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Based on our ability to foot the bills for standard of living we are often placed in socio-economic classes. The middle class is one long continuum before reaching affluent or HNI class. What I observed is, unforeseen events can push an individual and their families a notch or two below their current status more often than well planned savings and investments pushing individuals few notches above. Thereby it is easy to lose wealth than to gain and keep it safe, so extra care needs to be taken to preserve it. Someone who has an enviable lifestyle of a luxury apartment and a D segment car can lose it all within a month due to either a natural disaster or an accident which was never thought of.

These type of risks are tail risks, we are inherently optimistic and given the low probability of these high impact events we always think that such cases never happen. So we never have a mitigation plan in place. These risks when materialising will not just cause a setback, it ruins. Tail risks cumulatively increases, which means though as a single risk in single exposure looks negligible, multi risk, multi exposure over time will increase the likelihood of ruin very much.

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Consider the following risks taken together – You don’t wear a helmet while riding a motorcycle, you frequently ride in the night in accident prone highways, you don’t sleep well often, you don’t eat a balanced diet, your motorcycle is not maintained routinely. The combined risk of having a serious injury has a very high likelihood thereby leading to a ruin.

Some tail risks like lifestyle diseases can be avoided altogether with a healthy lifestyle, many others like a geopolitical instability can’t be mitigated but can only be prepared to sail through with diversification of holdings. Insurance is a good option against many unforeseen circumstances, though many people view insurance as a expense, it is a way of paying it forward and praying such a scenario never happens. Someone not paying for insurance will have some money left in hand but at the grave risk of losing it all.

Identifying the tail risks in our life and planning for a mitigation is very much necessary. Being poor is expensive, once we are knocked off the socio-economic position, it is very difficult to claw back on to the same position. Mitigations are not just insurance, it is healthy lifestyle, adherence to safety standards, avoiding risky behaviours, hedging, diversification etc.

I like Nasim Taleb’s work on this topic and much more on probabilities. We don’t realise the skin in the game in the long term as we are too short sighted as a common human.

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In the last blogs we saw how debt inflates our needs for bigger purchases and traps us into situations that are undesirable like tolerating bad work culture, poor working conditions etc. Next step in achieving resilience is to avoid the marketing traps especially the ones that call your money “Disposable”.

A lot of people get into buying properties on loan because they would spend the money on luxuries when they see a big withdraw-able balance and it is growing month on month. People prefer being locked into long hefty repayments to prevent the temptation to dispose off the money, so they will end up with a housing loan with hefty repayments. The reason for this mindset is, any money left over after taxes and essentials (rent, medical, food, utilities, child care etc) is called disposable. Forcing us to prime it such a way to spend.

If we ask someone what will they do if they have million dollars, a vast majority of people will give ideas on how to spend a million dollars like buying an exotic car, expensive jewelleries etc which may bring joy momentarily but also drag the wealth down by many notches. While we need to spend on joy to remain sane, how much of it is required is the question we need to answer. By default we humans are hedonistic, we will keep wanting more and more of the same thing or something bigger than what we want. So we will end up disposing what we have in hand without thinking twice.

Unless we think about the cash in hand as a capital than disposable money, we would not have the mindset to invest large sums of money across different asset classes which makes us resilient. Replace the term ‘disposable income’ with ‘discretionary income’ that is waiting for its business owner to be invested. You will realise ways to budget spends for joy and standard of living, yet set money aside for investments. Best piece of advise I got from a friend was to create two other bank accounts apart from the salary account. One is to keep 3-4 months of expenditures for emergency usage and another one to fund SIPs, equities and loans. The moment salary arrives, the account is left only with budgeted money for essentials, living standards and joy and the rest goes to investments. In other words, the disposable income becomes limited. This helps in not succumbing to temptation to spend until zero or buy a huge property with hefty repayments so that we will not spend it away.

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My grandfather never borrowed for anything. His guiding lines for me were – Using borrowed money is like fuelling the fire using hay, it burns fast and gets consumed quickly but when we want to repay we will be paying in firewood for the same volume of hay which could have served us much more. Another mentor quoted a text when I wanted to buy a flashy car much in my early career – We buy things we don’t need, with money we don’t have, to impress people we don’t like.

Both those texts are my guiding lines for debt management now, but adopted it much later when I learnt it the hard way. Two of the biggest purchases in one’s life, a house and a car, often don’t stop at needs but end up as a status symbol. People love to show that they have arrived and achieved. In reality no house or car is big or luxurious enough over time. So people go all out and buy things that are not affordable. Loans were initially meant to lent out to people seeking business capital. Those were risky so banks turned to milk the retail borrowers – ‘us’. Affordable loans are oxymorons, if you are going for a loan to buy something then you cannot afford it.

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Negotiating for big purchases with cash in hand vs taking loans has a big difference. We are hard on our future selves but care for who we are today so the cash in hand looks heavier and hard earned while the loan repayments broken down over the months in the future looks small and affordable; inflating the overall demand and reducing the willingness to negotiate.

When we buy larger than our needs, we commit to a monthly outflow which we cannot afford to skip because it will bite back with more penalties. This is the single biggest factor which contributes to workplace stress; people put up with toxic work cultures, long working hours and bad bosses in the fear of losing the lifestyle they signed into.

On the contrary, if we save up for paying the big purchases we will negotiate hard with the money in hand, we will not be a victim to the need of hefty monthly payments, which gives the clarity of thoughts to take crucial career decisions. You can buy a dream house by SIP route within 7-8 years of saving the same money that we will be paying for 20 years for a home loan. Once I was in a car showroom where I observed a guy talking to the salesman for the model he wanted.

Salesman: Please let me know what is your monthly salary, I will let you know which car you will be sanctioned?

Buyer: I wanted the top end model, in that specific color and rims.

Salesman: In order to proceed I need to know your ability to pay month on month, I can work out the interest rates and tenure:

Buyer: Gives a cheque and says – Fill it with the price that you are offering that will make me sign and drive the car out.

The salesman was stumped and the buyer negotiated almost 10% off the vehicle.

Debts are for businesses to quickly turnaround profits and not for building assets over 20 year loans. Try the no debt strategy, this means you will have money in your account you don’t know what to do with. This is the first step in being financially resilient, there is no pressure to pay huge bills month on month. The next thing is to resist the urge to spend and build up moveable assets. More on subsequent posts.