Savings and Investment- Part 1

Before starting with this post, let me warn you that I am not an expert in investments and I do not claim responsibility for any actions taken based on this post. This applies for all my blog posts!

This will be a two part post. In the first post, I will give some fundamental ‘gyan’ on savings and the characteristics of basic asset classes. In the second post, I will try to give an idea on how exactly to proceed with things on the ground.

Savings Account
All of us earn. And all of us spend. Most of us manage to save something at the end of the day, which we put into banks. But, is putting money into banks really saving? Technically speaking, it is not. All of us have savings accounts, which generally give an annual interest rate of 3-4%. The actual inflation rate in India today is around 10% (Don’t go by the govt’s WPI figure of 8%. CPI is the worldwide standard, which is not measured in India and is typically 1-2% above WPI). This means that the value of the money you hold in your pocket is decreasing by 10% every year. i.e., if Rs.100 can buy you 10 chocolates today, the same Rs.100 can buy you only 9 chocolates after 1 year. So you know that high inflation is a real killer of money value. Most of us get a salary raise every year. Let’s assume that on an average we get an annual raise of 15%. Let’s also assume that the long term (over a 20 year period) inflation rate (CPI) for India will be 7%. This means that, in effect your salary increases by approximately 8% year on year. That is a pretty decent number. But consider your savings. Let’s assume that you save 20% of your salary every year and leave it in your saving account. This amount will grow nominally by 3% every year. In real terms, you have actually lost approximately 4% of your savings. If your annual salary is Rs.5 lac, a devil called Inflation just ate Rs.4000 of your hard earned money. You would have been better off spending those Rs. 4000 on buying yourself some new clothes rather than see it vanish into thin air like this! So you now know that Savings Account is a bad guy and you should limit your association with him. But Savings Account is a necessary evil for all of us because he is the most liquid asset apart from cash in hand.

Fixed Deposit
Today banks give 8% on FD. Considering that inflation is 10%, this is a slightly better choice than a savings account. But the downside is, FD lacks in liquidity. Since your money is locked-in for a fixed period, you may not have access to your money when you need it.

Gold
Gold is the traditional inflation fighting tool. Over the years, the price of gold has managed to keep pace with inflation. If you want to protect your savings against inflation, then gold is one of the safest bets. But due to the emergence of bullion/commodity markets, gold prices are bound to fluctuate; but over the long term, gold inevitably keeps pace with inflation.

Equities
Now, lets come to the interesting part. The asset classes that we’ve discussed till now are conservative with little or no risk of loss in face value. But with no risk, comes no reward. Equities or stocks, are an exciting asset class which actually help your savings to grow. Investing in stocks is like giving your money to a businessman who will use it to build and grow his business. When he makes a profit, he gives you a share of it. As we know, at all times, there are businesses that make profits in the economy. Hence there is always money to be made by investing in stocks. But again, like gold, stocks are affected by traders and speculators. Hence their prices do not always reflect their true value and they are vulnerable to short term volatility driven by “market sentiment”. This implies that there is risk involved even when you invest in a good business/stock. Knowledgeable investors will always make money in the equity market if they stay invested for the long term. Trouble is-most of us are not knowledgeable investors. So it makes sense to take professional advice. Go to Mutual Funds and stick with a fund for the long term. You will be rewarded.

Real Estate
How can one ignore this asset class. Everyone dreams of owning a house. There are some of us, who are lucky enough to afford a second or third home. For people with such kind of surplus money, real estate is a good option to have. During times of economic boom, returns from real estate can be mouth watering. But there are many risks associated with real estate. Lack of liquidity is the biggest risk associated with owning property. But if you are smart with your decisions and not too aggressive, buying property with your surplus money is a good thing to do. But again, remember that you are not an expert real estate dealer; So be conservative with your choice and stay invested for the long term.


This brings us to the end of this part. In the next part, I will dwell a bit on some of the more sophisticated saving/investment instruments and also hopefully give some broad guidelines on managing your savings.