First conserve then consume

You must work towards building conservation assets,not only consumption assets

Assets are good,we like to have assets and its definitely a good idea too,to have assets. Just that there are two types of assets viz.,Consumption Assets and Conservation Assets. Consumption assets are assets that we consume each day of life in some form or manner. The value of such assets depreciates over time. Accordingly conservation assets are assets that prima facie conserve wealth and over time appreciate in value as well. Often while we are busy and rushing from one meeting to another; from one project to another; from one assignment to another,we manage to create just about one,single conservation asset i.e. our residential home. And thats more driven by the necessity of having a roof over ones head and not really from the perspective of wealth creation.

Consumption assets,just far too many

The way we live our lives we quickly tend to create far more consumption assets. Sure it is important to have a BlackBerry or latest iPhone in work circles. It is nice to have the child learning Japanese handicraft. It is nice to be able to have all window air-conditioners replaced by split ones that are quieter and more stylish. It is nice to be able to upgrade from your old Maruti to a brand new Toyota Altis. It is essential that diwali is spent at exotic and unexplored locations for example,Turkey. It is perhaps important to have such items as they bring us happiness and place us on a higher stratum of social status. These assets give us a lot of satisfaction and because we feel we can afford it we undertake such purchase decisions. Nothing wrong with this except that for every rupee spent in such assets if we do not forget to spend about double into a conservation asset. It is as simple as that. Over time you will have a vast collection of digital photo,treasure house of goods and pleasant memories and so much to speak about everything in life except your portfolio statement.

Zero or near zero value

These consumption assets have a general rule. They never appreciate and always fall or depreciate in value. Infact some have zero value as soon as you are done spending e.g. a holiday or a fine-dining experience. This experience is then your asset and in monetary terms once you are done with it the value is zero.

Some assets gradually depreciate over time,some not only depreciate but worse,they give us a liability to live with for many years to come e.g. a car with a car loan. As soon as you drive the car out from the showroom it loses anywhere between 10 to 20 per cent of its value. These assets are necessary and no doubt about that. But there might be a better method of doing this.

Extraction of funds

The best way without any element of doubt to buy consumption assets is out of profits of investments. But that is somehow not possible for most people as they only save and do not really invest,so question of profits for most people is not relevant. Following are 2 scenarios of buying a consumption asset,say a car worth Rs 10 lakh.

Option 1

You have the money and buy it outright and money is consumed. At the end of 5 years your net worth on this asset is say 20 per cent of the value i.e. about Rs 2 lakh.

Option 2

You have the money and decide to take a loan for 80 per cent of the value assuming you can afford the EMI and are eligible for such vehicle loan and invest your own money smartly. You put in Rs 2 lakh as your down payment and EMI being about Rs 18,000 based on 12 per cent interest rate on your loan.

Story continues below this ad

Over the end of 5 years you have paid about Rs 10.7 lakh to purchase the car inclusive of Rs 2.7 lakh being interest.

At the end of 5 years your net worth on this asset is Rs 7.3 lakh. Wondering how? Your invested Rs 8 lakh are now worth about Rs 16 lakh plus Rs 2 lakh the salvage value of car minus Rs 10.7 lakh paid so far. What are you left with? Rs 7.3 lakh.

Is this a better option?

Surely,and this is possible.

Now if you were to follow the rule stated above that for each rupee spent,conserve two. This would mean you need to have Rs 20 lakh of investments to be able to buy a Rs 10 lakh car. In this case your networth at end of 5 years under suggested option 2 would be about Rs 27 lakh. In this case you would have started your purchase planning Rs 18 lakh and at the end of 5 years you had Rs 27 lakh,excess being Rs 9 lakh.

Another way of looking at this is that; the investments you had pretty much paid for the consumption asset. Sure you might feel you can do this only when you have assets aka investments. But you have got to start somewhere first. If you keep spending on consumption without conservation then this will not be possible.

Story continues below this ad

You can work with a simple guiding rule; Consumption i.e. depreciating assets must pay for themselves because over time they will have little or no value. Such methods of buying depreciating assets are also a part of prudent Financial Planning.

Financial planning shows you a roadmap of how not to compromise and how to optimise money even while you are purchasing a consumption asset.

Author is Founder-Director,Transcend Consulting