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Saving for a Better Future

You can save a lot and yet be forced to be miserly when you need money. The slip between the cup and the lip can happen if you haven’t invested your savings and given it the right opportunity to grow. On an average, Indians are saving more, but the savings are being invested in lower risk lower return options such as bank fixed deposits, provident funds or traditional life insurance products. Some investments of this sort happen by default. Employees’ Provident Fund (EPF) is a case in point, where 12 per cent of your basic pay gets stashed away every month. Many of us open recurring deposit accounts in banks to save towards medium - to - long - term goals. Besides a lack of awareness of options that bring higher returns, absence of quality financial advice makes people invest money in bank fixed deposits.

THE REAL RETURN

The return from most fixed income products, including bank fixed deposits, is nominal. The interest income is subject to income tax. The entire interest income is added to one’s income and taxed accordingly. Thus, the post tax return gets reduced. Post-inflation, the value is reduced further. The actual return, i.e., return adjusted to inflation and tax, doesn’t help in creating wealth over the long term. At best, it might help you preserve your capital.

THE PARKING

You should park your savings in assets that will generate returns much higher than inflation. Past studies have suggested that equity delivers the highest inflation-adjusted returns among all asset classes over the long-term. The rule is, the longer you remain invested in equity, higher is your return.

COMPOUNDING

If you start early, you save more from the power of compounding, even if you start with a small amount. The rule is to invest COMPOUNDING If you start early, you save more from the power of compounding, even if you start with a small amount. The rule is to invest regularly and keep reinvesting the returns. As an example, Sunil invests ₹2,500 every month from the age of 25. His friend Anil starts saving ₹5,000 every month 10 years later. At the age of 45, on a realistic 12 per cent return, Sunil’s kitty is a sizeable ₹22.78 lakh, while Anil’s is nearly half at ₹11.09 lakh.

HOW TO BENEFIT

To benefit from the long-term return potential of equities, make an early start. This will help you remain invested for a longer period and help you meet your goals in a timely manner. The better approach towards equity-based products like equity mutual funds (MFs) is through systematic investment plans (SIPs). One may start daily, weekly or even monthly SIP’s in equity MFs of one’s choice. This helps you with ‘forced savings’ and also gives you a headstart. If you start saving from the age of, say, 25, when you are likely to be in your first job, you can save around 10 per cent of your net income till your marriage. Here, even if your savings take a dip a bit, the headstart gives you the extra advantage.

CONCLUSION

One needs to upgrade from mere savings into the mode of active investing. Identify goals based on tenure. Link long-term goals to your long-term investments primarily through equities. For medium-term goals, benefit from a mix of debt and equity asset classes. The stock market remains volatile over the short-to-medium term, but averages out over the long-term. So, the reason to stay invested in a scheme, or to exit it, should not be based on sentiments. An investor who has seen the ups and downs of the stock market remains poised for the long haul and is largely undisturbed by such frequent fluctuations. Also, mistakes made during the initial days of investing can help you master its basics.

Next To Come: Goal Based Approach