Indians traditionally have a different socio-economic ecosystem when compared to many of the western economies. Our ecosystem is less reliant on social security provisions and working professionals attempt to save a significant part of their monthly income for their future needs. These savings are envisaged to provide for medical needs, their children’s education and marriage needs and sustenance for old life. But how does such needs get systematically eroded?
A lot of times, people end up saving money in their savings bank account, with the hope that the money will support them in times of need. However, what most of us don’t realize is that the money in savings accounts is practically dead money. Not only is the money generating interest at only 4 or 4.5 per cent, it is depreciating in terms of its real value. Allow me to explain why.
At any point of time, the real inflation rate in the Indian economy have varied around 6-10 percent in the last few years. The inflation rate is an indicator that if you buy a fixed number of items (say 100 toffees at the unit price of 1 Rupees) for a fixed sum of money (say 100 Rupees), the next year for the same amount of money (100 Rupees) you would be able to buy a smaller number of the same set of items (say 92 toffees). However, you may argue that since you keep the money in your savings account, it appreciates at the rate of 4 percent annually. So, to account for the interest, the amount deposited in savings bank account appreciates from interest (say to 104 rupees). However, even with the interest accumulated in Savings, after accounting for income tax deduction, instead of being able to buy 100 toffees, one would be able to buy probably 95 toffees in the subsequent year.
Year on year, the money kept in savings account get systematically eroded. The inflation rate is increasing at a much greater pace than the interest rate one could get on their savings account, hence eating into savings. For even the savings account to protect the actual sum, the rate of interest would have to be at least the rate of inflation plus the income tax rate (which would easily mean over 10 percent for an average mid-career professional in current scenario).
What can one do to address this systematic depreciation of the hard-earned savings? Some prefer to go for fixed deposits where for mid-income professionals some respite is also provided from income tax exemption. However fixed deposits are only marginally better, though there are a lot less risk free than mutual funds. It probably just balances out the real inflation but is not suitable for anyone in the higher slabs of taxable income.
The only option for such professionals to protect their savings is to look for instruments like mutual funds to protect their savings while accounting for all possible erosion of the principal and get some real appreciation. While mutual funds are subject to market risks, it has been seen that the mutual funds from reputed houses end up providing an appreciation of around 12% (sometimes higher too) over the base principal and thus the real year on year increase is around 4-5 per cent. This is much higher than any other financial instrument, which is of similar or lower risk.
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