At SmartRupee, we operate on a simple premise: that most people need help figuring out how to save, and they need help figuring out how much to save, and where to put that money. We say this not so much as a critique, but more as a challenge we posed to ourselves when designing this app. What does it mean to build a financial model? What are the key areas we are trying to hit? And how do we calculate them?
So, to the first point: most financial apps are based around a user’s current expenditure patterns, and try to adjust savings around that – some a little, some a little less. We threw that model out the window.
Instead, we came up with a model centered around the kinds of items that people typically need to save for: retirement, emergency or short-term cash needs, real estate saving, children’s education, and children’s weddings. Our assumption is that most people’s basic financial needs will be met once they are able to save for these five big-ticket items (we include buying a car in short-term cash needs).
Once these goals are hit, you can then spend the rest of your income in whatever manner you choose.
Let us break down each component to see how SmartRupee arrives at each goal:
The first thing we try to do is calculate how much income you will need in retirement, which is a function not just of your current income, but also of your starting salary at the beginning of your career (which gives us an estimate of your income growth trajectory), and – as with everything in financial planning – inflation.
In our model, we ask you to input two figures: your monthly salary right now, and your monthly salary when you started. The model first calculates your income growth rate from the difference between when you started, and your income now. It seeks to estimate your income using a combination of your own income trajectory in your career thus far, coupled with estimates of lifetime income trajectories across the economy as a whole. It then estimates your inflation-adjusted monthly income immediately prior to retirement, and assumes that this is the amount you will need to continue into retirement.
Once we calculate how much you need per month, we multiply that amount to arrive at how much you will need per year. The formula for this is complex, but what we can tell you is that the total amount you need to save up for comes out to approximately 25 times your annual income needs. This amount will expect to last you comfortably through a 25-30 year retirement, meaning if you decide to retire at the age of 65, you will likely have money to last you through well into your mid-90s.
One note about inflation: we calculate both absolute and inflation-adjusted amounts, but only display inflation-adjusted numbers to you for the retirement calculation. Why? Because the unadjusted numbers would make no sense to you. Inflation in Pakistan is so high that those numbers would be astronomically large, but also would not tell you about your purchasing power.
In order to solve that problem, we display only inflation-adjusted projections, so that you can understand – in today’s terms – how much money you will have in monthly retirement income and compare it to your existing lifestyle.
Emergency or short-term cash
This is a somewhat catch-all phrase, but it is meant to capture two distinct categories: cash you may need for emergencies (things happen, and you would ideally not have to borrow money for situations where you need something extra), and any short-term needs you may have. The short-term needs can include things like saving up for a car or motorcycle, going on a vacation, etc.
Ideally, of course, one would want this to be a number as large as possible to feel completely safe, but one needs to be realistic. At Elphinstone, however, we have determined that the benchmark people should have at all times is three times their monthly salary: if you have that much, you should feel like you can handle short-term cash needs or most emergencies.
Of course, sometimes life can throw even bigger surprises at you, and nobody can be 100% prepared for everything. But this much will help you be prepared for many things that may come your way, and we will help you save a little each month until you hit this point.
Real estate saving
We make the assumption that the vast majority of Pakistanis may have a home that is owned by their family, but that they would still like to buy their own home, and we try to help them achieve that goal.
We ask two inputs for this part of the model: do you want to buy a home, and if so, at what age. The age matters because it determines how much time you have to save for a house, and what your income will be at the time you decide to buy your home.
If you decide to buy a home any time before the age of 55, we assume you may be willing to purchase a home on a mortgage, and would be willing to pay up to 25% of your expected income at the time (again, using our model to project your income trajectory) to make monthly mortgage payments. Based on that payment amount, we model how much of a mortgage you can afford, and how much you will have been able to save up for a down payment, based on your current age and estimated investment returns.
Adding your estimated down payment and estimated mortgage amount, we arrive at a number equal to the value of the home you will be able to buy. We then inflation-adjust that number back to the present day to give you an estimate of the value of the home you would be able to afford today, if you already had that much money. So, for instance, if our model says that you can afford a home worth – in inflation-adjusted terms – Rs10 million (1 crore), you can look up on real estate portals what kind of home you would be able to afford. Based on that, you can decide to save more or less according to your needs and desires.
For this section we have asked, how many children you have, when you plan to have them, and when you would like them to study. But really, when it comes down to it, we are answering two questions: one, what is the cost of a four year program, and two, what is the estimated inflation rate for the cost of education? As we know, costs of education have inflated exponentially in the last few decades, and we have kept that historical data in mind to calculate how much you would need to start saving now to be able to afford that future rate.
The reason for picking this is to be explored in another article; for now, let us focus on how we got there. Across multiple socioeconomic groups, we have found a pretty accurate tendency: in Pakistan a wedding costs six times as much as your expected monthly retirement income. Our model takes this into account once it calculates your expected monthly retirement income.
What we have done here is show that we did not come up with this model out of thin air. There is some thought about what number is reflected, the logic that goes into it, and why we have picked certain inputs. But we are also going to be exploring the themes behind these components, and a little more detailed math, in upcoming articles.