One of the things you hear from people who have lived both in the U.S and in India is “Indians save, Americans invest”. This is partly because risk taking behaviour is more common in Americans than Indians. It is also partly due to the fact that we, in India, do not have a safety net like the U.S. Social Security system.
However, youngsters do not have to follow in the footsteps of the previous generation. A young person today starts with a salary higher than the pay his father was drawing just before retirement. So, the ability to take a financial risk is high.
Tackling inflation
Firstly, look at why savings alone will not help you reach financial freedom. You are actually doing a smart thing when you put away some money for a rainy day. If you are parking this money in a fixed deposit for a year, you get around nine per cent interest, on which you have to pay tax. So, your effective return on your savings is a little over eight per cent.
This is a smart idea only as long as the price of the goods and services you consume do not increase by eight per cent annually. This includes things like food, rent, clothing, entertainment and fuel. Do you really think the prices here are going up only by eight per cent? If they increase by about 15 per cent, what happens to your money in the bank? You may get more than you put in but, even with the interest, your money does not buy what it could a year ago. When prices rise more than the risk-free interest rate, money loses value. Bank savings are risk-free because there is no uncertainty about what you get when the deposit matures; you almost always get your principal back unless the bank collapses.
There was a semblance of price stability many years ago and the interest rates from bank deposits were high. In the 1980s, the interest rates on bank deposits were quite high, in double digits; often over 15 per cent. Today, we get half of that in a world where the price of essential and non-essential items is hiked almost every other day.
Save for future
One other thing to remember is that the average life expectancy in India is also rising. The good news is that we will live longer (on an average, of course) compared to the previous generation. The bad news is that we will need money to take care of ourselves, as the society is moving away from the joint family system, which provided a proxy financial safety net.
So it is not enough to just save money. You should also invest. Investing is different from savings; there is a risk involved. All investments — land, apartments, houses, stocks, commodities, precious metals — are risky.
A risky investment usually — but not always — pays more than a risk-free investment like a bank deposit. So, what is the catch? The catch is that, the returns are variable. You may also lose a portion of your principal. If you buy an apartment, its price may go down. If you buy gold, its price may crash. This is the flip side of investing.
In our next column, we will see how we can look at investing in an intelligent manner.
Venkatesh is the co-founder and Director of Money-Wizards, a company engaged in financial literacy and money education for adults and college students. Details on workshops at Info@Money-Wizards.com
