- Investing for retirement, not saving, is prudence
If you go by the advertising blitzkrieg that calls for using investments for wealth creation, we all should be rich by now.
Yet, barely two out of 100 people choose mutual funds in India. This number is 35 out of 100 in a developed market like the US.
It is true that the number of mutual fund investors has gone up from where it was two years ago. Many are impressed by the Mutual Fund Sahi Hain campaign too. However, it is necessary that one chooses mutual funds over other investments for the right reasons.
Inflation is the enemy no 1
You invest regularly in your working years to have enough savings for a comfortable retirement. However, little do you realise that inflation eats into those savings bit by bit.
As years go by, you need more money to buy the same things. You might remember those conversations when your parents or grandparents have often talked about prices of gold when they got married. You were regaled in your childhood about stories when families ran households with a few hundred rupees. Elders say that people need much more money today than before. Primarily, these are stories about inflation.
Prices of goods and services are based on their demand and supply. When demand surges, prices rise. If your savings bank account gives you an interest rate of 4-5 per cent, inflation takes away most of that return, actually eroding the value of your money. This is because the inflation rate is mostly higher than the bank deposit rate. Hence, merely saving money in banks or fixed deposits is letting your wealth erode and not grow.
Not saving enough
Investment experts often say that your expenditure should be the money left after you account for your investments. Easier said than done, though. When you are young, you are concentrating more on spending money to purchase whatever the heart desires. The habit of saving does not manifest dramatically when you get married, have children and shoulder responsibilities. So, one should inculcate the habit early, but there is a fundamental problem.
While investing early is great, people do not know how to manage their monthly income and expenditure. If you do not have surplus money, you will never be able to begin investing. The surplus is not just going to land up in your pocket, it should be created. Before financial planning that advises smart investing, most people need some training on creating that investible surplus every month. In short, you need professional help for managing the monthly household budget. You need to learn new ways of saving money and curbing expenditure. There is no formula for that, it is just the way you lead your life that would make a difference in your bank balance.
Awareness about risk
The other important reason for failure to create wealth is the inability to understand the concept of risk. Financial investment is all about you getting on top of this. ‘Being aware’ is far more lucrative than adopting a ‘beware’ approach to investing. Considering that inflation eats into your savings, you can look at options that ensure the value of your money grows.
You are simply putting your money to work. If the average inflation rate was six per cent for the past 30 years, the average rate offered by public provident fund was just under 10 per cent. The government has further reduced it to below eight per cent now.
The government cannot afford to guarantee this rate if overall interest rates are low. In the past 30 years, the BSE Sensex has averaged an annual return of over 14 per cent. This is well over the prevailing inflation rate and any other savings instrument. Even gold has managed just over half of that rate. What differentiates the BSE Sensex from others is that the way to its returns in those 30 years is zigzag and not linear like a fixed income instrument.
This is because of the cyclical nature of the stock market. You need to train yourself to ride through a market down cycle and stay informed to make the most of the upside. For all practical purposes, one can say that wealth creation needs an ability to allocate savings towards equity. Investing regularly to beat inflation is the way to go.