Summary of this article
Use salary increments wisely: split between spending, needs, and investments discipline recommended.
Bonuses should prioritize debt repayment, enjoyment, and higher long term investing allocation.
Use STPs with debt funds to stagger equity investments and reduce volatility.
By Sanjay Chawla, CIO - Equity, Baroda BNP Paribas Asset Management India Pvt. Ltd
A bonus or salary hike can make life feel easier, but it also brings a decision: spend it all now or use part of it to build a stronger future. But while the first instinct may be to spend more, the smarter move is to pause and plan. You should enjoy some of the reward today, while setting aside enough to grow your wealth over time.
25-year-old Megha is super excited after her new job earned her a 30 per cent jump over her previous one. If, like Megha, a bonus or a salary hike has come your way this year, that’s worth acknowledging. The moment the extra amount hits your account, everything that seemed like a luxury in the past suddenly feels affordable. A better phone, a nicer vacation, or a bigger purchase may all seem within reach.
But the point is not to react to the bonus but to plan for it. You worked for the bonus, now you make it work for you. A small shift in what you do at this moment can make a real difference later.
The 50/20/30 rule
When your salary goes up, keep it simple. The book All Your Worth: The Ultimate Lifetime Money Plan advocates a 50/20/30 rule, which says up to 50 per cent of your after-tax income can be allocated to needs, i.e. must-have or must-do items, another 30 per cent on things you want but don’t necessarily need, i.e. indulging your desires and 20% into savings.
However, financial planners say that this rule, insofar as it concerns pay hikes, should actually be 50 per cent investment, 30 per cent needs and 20 per cent desires. If, however, your financial plan is ahead of track, then the apportionment can be 40 per cent investment, 30 per cent needs and 30 per cent desires.
Let’s illustrate the application of this rule practically. If your salary increases by Rs 10,000, split the increment into two halves of Rs 5000 each. Use one half for splurging on what your heart has most desired and for meeting immediate needs. The balance of Rs 5,000 is invested in stepping up your SIP (Systematic Investment Plan) to help your savings keep pace with your upgraded lifestyle.
You still get to enjoy the extra income, but you also make sure some of it starts working for you. Expenses don’t rise as quickly as income, so this is usually easier than it sounds.
Bonus vs increments
Shiv’s profession has a larger variable component in his salary structure, and he receives a hefty performance-linked bonus at the end of the year. Unlike Megha, who can afford to step up her SIP from her increment, Shiv’s situation is slightly different. As compared to a salary increase, a bonus is often variable and not something that recurs on a monthly basis.
Let’s assume Shiv got a bonus of Rs 1 lakh. Before doing anything else, Shiv needs to check if he has any high-interest debt on his credit cards or personal loans. Clearing those is often the smartest first step. Assuming he had Rs 30,000 due on his credit cards and personal loans, he should first pay this off. He can then indulge another Rs 20,000 for his immediate desires. The balance of Rs 50,000 should be invested to create wealth in the future. In this case, the rule applicable would be 30 per cent needs, 20 per cent desires, 50 per cent investments. The investments component of a bonus is higher because there is a high degree of uncertainty around bonuses that depend on a mix of individual and company performance. So, putting away a larger chunk for a rainy day allows you to have money available in years when the bonus is much lower.
How to invest your savings?
This Rs 50,000 investment shouldn’t be put into the equity market in one go. The market doesn’t move in a straight line, and timing it right is difficult.
A more balanced approach is to use something like an STP (Systematic Transfer Plan). Park the amount to be invested in a relatively low-risk debt fund, such as a Liquid, Money Market, or Ultra-short duration fund. This will ensure your money continues to earn income while awaiting deployment in the equity fund of your choice.
Staggered investments via STPs help spread investments across multiple periods, effectively averaging the cost of investing and reducing the impact of market volatility. It’s a simple way to spread out your investment instead of taking all the risk at once.
The real lesson is simple: do not let a raise or bonus pass without intention. Enjoy a part of it, use some of it for immediate needs and make sure a meaningful portion is directed toward long-term growth. Don’t lose sight of your financial goals. You will be surprised as to how big a difference this makes over long periods of time, and yes, congratulations on your bonus and increment. You deserve it!!
Disclaimers:
The material contained herein has been obtained from publicly available information, internally developed data, and other sources believed to be reliable, but Baroda BNP Paribas Asset Management India Private Limited (BBNPP) makes no representation that it is accurate or complete. BBNPP has no obligation to tell the recipient when opinions or information given herein change. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. This information is meant for general reading purposes only and is not meant to serve as a professional guide for the readers. Except for the historical information contained herein, statements in this publication, which contain words or phrases such as ‘will’, ‘would’, etc., and similar expressions or variations of such expressions, may constitute forward-looking statements. These forward-looking statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those suggested by the forward-looking statements. BBNPP undertakes no obligation to update forward-looking statements to reflect events or circumstances after the date thereof. Words like believe/belief are the independent perception of the Fund Manager and do not constitute opinion or advice. This information is not intended to be an offer to see or a solicitation for the purchase or sale of any financial product or instrument. The investment strategy stated above is for illustration purposes only and may or may not be suitable for all investors. The information should not be construed as investment advice, and investors are requested to consult their investment advisor and arrive at an informed decision before making any investments. The Trustee, AMC, Mutual Fund, their directors, officers, or their employees shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages arising out of the information contained in this document.
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