Savings and Investments

March is round the corner and people are scurrying to save tax. To the extent that it has replaced the  office gossips :( . But saving is not only about 'saving taxes'.
Of late, I have read a lot of literature on saving/investing ( and believe me there is no dearth of it! ). So, I decided to share it with other 'poor' souls like me before it slips off my mind.


Disclaimer: Please use your own head before making any investment decision :).

Saving and Investing are two different things. Saving is like storing your money at your home (more appropriately a savings bank account), while Investing is giving off your money(FD,NSC,PPF,ULIP,MF..) so that it can grow.

Why shouldn't you save: A saving accounts gives about 3-4% of annual interest. Inflation at present is, say 6% (inflation takes the value of Rs.100 in next year into account . You would have observed that what can be bought for Rs.100 diminishes every year. Didn't you hear your grandfather ruing that Rs.100 was enough for buying the ration for whole year in their times? A 6% inflation means that on an average things are becoming dearer by 6% every year.). Inflation is the devil here. And if the recent trend is an example of things to come, annual inflation may well be 7-8% for years to come!.

So Rs.100 in savings account becomes 104 at end of year but inflation reduces it  to 98.11 (104/1.06). At the end of the year you actually lost Rs.2 per Rs.100 ! By now, you must have understood that by keeping your money in savings account you are actually incurring a loss every year and that, for growing your money, you should invest your money such that it earns an interest of at least more than average inflation rate. This is not to say that you invest all your money, experts advise to keep 4-6 months of your expenses in savings account.

Roughly speaking, there are two modes of investing:

• Debt schemes
• Equity schemes

Debt Schemes: When you invest in Debt schemes, you lend your money to someone who is willing to pay interest in return. The popular debt schemes are:

1. Fixed/Recurring Deposits: You lend money to the bank and it pays you 7-10% of interest rate. The bright ones would have got it, it's more than the inflation rate ( by the way, did you notice that as inflation rises, interest rates on deposits rise too - can somebody explain? )
   National Savings Certificate/Kisan Vikas Patra : You lend your money to Government of India(GOI). Interest rates at present are at almost 8.4%  annually.
2. Government/Infrastructure/Company bonds: You lend your money to  GOI or public/private enterprises. Interest rate differs from company to company ( i will get back to why this happens)
3. Traditional Life Insurance: Here, you are mixing insurance and investment which is a bad idea according to people. Anyways, insurance companies generally invest in the above debt schemes on your behalf. As you would have guessed, interest rate will be less than 8% because insurance companies need to cover the risk of paying claims( which means giving out more money than what you gave them, poor guys!)

We will take a moment to get back to the question in point 2. Why interest rates on bonds differ from company to company? Well, suppose I own a ABH corp. Will you lend me money at 8% ? ( as a wise investor you should think: what are the chances of ABH corp going bankrupt?) . Now, would you lend me money at 20% (you have begun to think that may be i can, isn't it!)?  So generally speaking you will receive less interest on government/public sector bonds and more on private sector bonds according to the risk involved.

Equity Schemes: When you invest in equity, you own a pat of the company you invest in and share the risks with other investors ( if you bought 100 shares of ABH corp at 10 rs each  and  the shares fall to rs.5, you lost 500 rupees!). The company might be willing to pay you for sharing risk (as dividends) though this is not guaranteed. You make profit if company makes profit and you lose money if the company incurs losses. The various ways of investing in equity are:

1. The Stock Exchange: You can buy and sell shares of companies with a demat account.
2. Mutual Funds: The fund house takes money from you and buys/sells shares on your behalf. The fund house gets its cut for managing your investment.
3. ULIPs: Again these mix insurance and investment. Unlike traditional insurance, ULIPs invest your money in shares so the maturity amount is not fixed.

Wait, what about the interest rates on equity investment? Well, it's not fixed and it varies for each individual according to the shares, MFs and ULIPs he buys. However, generally speaking over a period of time (4-5 years), equity has 'always' given better returns than debt schemes. Why more than debt schemes? Because you took risk. When you lend to government or even a private company which is governed by so many regulations (think of SEBI), you are not generally risking your money.

So. why not invest all money in equity? Simply because it involves risk. What if you invested all your money in equity and needed a lot of it in 2007 when the share market was at it's lowest?, think over it, you could have recieved less than what you invested!

My advice (if you will take it) : Do some research before investing. The percentage of your investments in debt and equity should vary according to your risk taking capability.

P.S. Happy Investing!