Demonetization is perhaps the most used 14-letter word in the world since 8th November 2016; that’s one advantage at least with India’s population and WhatsApp’s popularity in the country. So let me not use it again for the rest of this article!
One of the most obvious and structural impact of this historic change is that almost all the cash in public circulation in India - everything white, and apparently a lot of black too – is being channelized into the banking system. That puts forth an interesting challenge, which many of us have not thought of seriously in the past – what happens to your money in your savings bank account, and what would you rather do with it?
I grew up with my senior generation always advising me that banks were the best place to keep idle money, in fact they were awesome because they kept your money safe and paid you interest too! If you were somewhat financially savvy, then the more evolved way of saving and growing your money was to park it in fixed deposits. Anybody wanting to set aside any surplus cash for future, would just ‘go do an FD’. Investing in stocks was only for the super-intellectuals or the punters, and other debt / fixed income securities were not at all understood as investment vehicles.
So what has changed since then? First, people now do commonly think of investing ‘excess money’ into avenues like equities and fixed income securities, often through mutual funds or direct equities, and second, the services of certified financial planners are more sought after. But the definition of excess money itself has changed over a generation. With widespread acceptance of digital money, and now with the changes brought about by the popular 14-letter, any money that you have in your savings bank for more than a day can be counted as excess!
Let’s understand this clearly. The real purpose of a savings bank account is not to earn interest, but simply to provide liquidity for everyday transactions to individuals. In fact, any money that earns 4% interest in a savings bank actually loses value given the high inflationin India.
One can examine the inflation figures in India in the last 20 years (1996-2015) as per the Government of India records to understand this better. The official consumer price index (CPI) which takes the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care, has grown over the last 20 years at an average compounded rate of ~7.1%. This means that the same basket of good that cost you Rs 1.0 lakh in 1995 would cost Rs 3.9 lakh in 2016. But if you kept Rs 1.0 lakh in your savings bank in 1995 and kept earning 4% interest on it, that money would have grown up to only Rs 2.2 lakh by 2016. This is not only true for a 20-year period, but even for a year or a month!
So now times for some answers. What should you do with this money? Of course, you should load whatever digital wallet you prefer with appropriate amount that you need for a week or even for small expenses for a month, and let’s also leave aside some money as buffer for about 15 days into the savings bank. But for the rest of the money, here is what you do.Money that you are unlikely to need for five years or more:
Whatever be one’s income, a portion of that should always be saved for the future. If this money has no pre-determined use for the next five years or more, it should be parked in equities, which provide best comparative returns over a longer period. Based on historic evidence, with ~10% average annualized returns from the BSE Sensex
over the last 20 years, Rs 1.0 lakh invested in equity markets in 1995 would have grown to an astounding Rs 6.7 lakh by now, that too with tax benefits if you invested through mutual funds.
However, there are two aspects to watch out for when investing in equities. First, you need to have the patience to let that money stay invested for a longer period and the appetite to absorb the interim ups and downs of stocks markets. Second, you should do it with the help of a qualified financial advisor, who can judge your risk appetite and investment tenure and advise you the right products accordingly. For instance, if you have a longer term than 8-10 years in mind, you can opt for mid-cap stocks, but between 5-8 years of investment horizon, you should only look at a large cap stock portfolio.Money that you are unlikely to need for 1-5 years:
Anything that you feel you may not need for next 1 year but may need within 1-5 years should be parked in lower risk instruments like fixed income securities. Comparative evaluation of retail products that invest in fix income securities reveals that debt mutual funds are the best bet for the common investors, when compared to other similar risk-products like fixed deposits, national savings certificates (NSCs), public provident fund (PPF). Debt mutual funds offer the best combination of liquidity (can be withdrawn anytime and money hits your bank account in a day’s time), tax efficiency (benefits of long-term capital gain after three year of investment, taxed at 20% after accounting for indexation), and returns (consistently generation 0.5-1.5% better pre-tax returns than other similar products).Money that you are likely to need within one year:
Now this is the aspect where most people falter. They often keep funds that they are not going to use for many months in the savings bank. Remember, you are losing value on that money since inflation is growing faster than your savings bank interest!
The ideal thing to do with such money is to move it in ultra-short term debt funds, or money market funds (also called liquid funds). These funds would give you returns which are likely to be better than inflation (ranging between 6-7% in recent times), and are available to you easily even within a day. There are innovative products in the market now that let you redeem your liquid fund investments instantly through IMPS, or even draw your money directly from an ATM through a linked debit card! While some of these user-friendly innovations will take time to stabilize and get more popularly accepted, it is a no-brainer to keep only a few weeks or at best a month’s requirements into the savings bank and park the rest into liquid mutual funds of reputed asset management companies which have a good track record and come with very low management expenses.
So the next time you discuss the 14-letter subject with your friends or family, do not forget to tell them what to do with the money they are depositing in their savings bank. Better still, just send them a link to this article!