This is a guest post from Raag Vamdatt – An expert in the field of finance. He blogs at RaagVamdatt.com.
You have been eyeing that dream bike of yours for years. In fact, you have been dreaming about owning it since you were in college. And now that you have started earning, you are itching to finally lay your hands on it! The questions is – how do you get together the money to buy it?
Take a loan or save for your bike?
This is the very first thing you need to answer while considering a bike purchase.
Taking a loan means:
- You get your bike instantly
- You pay a lot of money in interest
- You pay a monthly EMI, which reduces your ability to spend on other things and save for the future
- Even if there are financial issues like job loss, you have to keep paying the EMIs
Compared to this, saving for your bike means:
- You do not pay interest – instead, you earn interest on your savings
- If there are financial issues or change in priorities, you can always divert the saved money elsewhere
- You do not get your bike right away
Considering these factors, it makes a lot of financial sense to save for the bike instead of buying it through an auto loan.
How to save for your bike?
So how do you save for your bike? And how much should you be keeping aside every month?
That depends on many factors – let’s discuss each briefly.
Price of the bike: This is a no brainer – the costlier the bike you want to buy, the more you have to save every month! However, it also depends on when you want to buy the bike, which is the next factor.
Time till the purchase: The further away the purchase, the lesser you have to save each month. This is also simple – if the bike purchase is a longer time away, you have to keep aside a smaller amount every month, because you get more time to save for your bike. Also, you gain from the compounding effect.
So if you can postpone the purchase for more number of years, you can buy your dream bike by saving a lesser amount every month. Or, you can buy a better bike by saving the same amount!
Rate of return on investment: When you are saving for your bike, you would be investing this money somewhere till you actually buy it. It can be anywhere – your savings account, a fixed deposit, a recurring deposit, mutual funds, shares, anywhere.
The rate of return you earn on this investment has an impact on how much you need to save every month. The higher the return from your investment, the lower is the per-month saving you need.
Let’s put all this together by looking at an example.
Let’s assume the following:
- You want to purchase a bike that costs Rs. 1 Lakh
- You are willing to wait for 3 years
- You plan to invest in bank FDs that give a rate of return of 8% per year
In this case, you would need to invest about Rs. 2,500 per month (the calculation follows).
Now let’s tweak each of the three assumptions – one at a time – to see what impact it has on your monthly saving needed.
- If the cost of the bike is Rs. 2 Lakhs instead of Rs. 1 Lakh (other things remaining the same), the monthly saving needed is Rs. 5,000
- If you can wait for 5 years instead of 3 (other things remaining the same), the monthly saving needed is Rs. 1,350
- If you invest your monthly savings at a rate of return of 11% instead of 8% (other things remaining the same), the monthly saving needed is about Rs. 2,400
How much do you need to save?
So how much exactly do you need to keep aside every month in order to purchase your dream bike?
We can use a function in MS Excel to find this value. The function is called “Future Value”, or FV. It goes like this:
- FV = The amount you want to spend on the bike
- A = Rate of return from your investment
- B = Number of years for which you would make the investment
- C = Amount needed to be invested every year
Type the following in an MS Excel cell (replace A and B with the actual values, and for C, put a value that is half the cost of the bike):
You would get an amount in the MS Excel cell as a result of this formula. Now, edit this formula and change the value of C till you get the price of the bike as the result of this formula.
This value of C is the amount needed to be invested every year. Divide it by 12, and you get the amount you need to save every month for your bike!
Tips on where to save
Where should you save your money every month? It depends on the time for which you want to save.
- If you are saving for 2 years or less, you should stick with fixed income. You can open a recurring deposit for this time period, so that you can invest a fixed amount every month.
- If you are saving for 3 years or more, you can invest in the stock market through a good diversified equity mutual fund. You can do this by starting a systematic investment plan (SIP) for this time period. You should start selling the MF units and put that money in a bank FD 1 year before the bike purchase.
Raag Vamdatt is a financial planner and is an MBA in Finance from NMIMS, Mumbai University. At Financial Planning Demystified – RaagVamdatt.com, he writes extensively about saving, investments, income tax, insurance, loans, etc. He also offers personal finance products and services that help you manage your finances better and save income tax.