Why we save money? It’s mainly for two reasons.
- For rainy days – Emergency fund
- For creating wealth – By a way of investing.
Saving money on its own can’t create wealth. We need to put our money on work. The job we assign to our money will decide our future wealth. It’s very important to select the right job for our savings. As you think of investing, What comes first in your mind? Fix bank deposits in the bank or purchasing precious metals like gold and silver. We think our job is done and dream of a wealthy future. As time passes you realize you are far behind than your financial goals. Why does this happen? You haven’t lost any money you invested but still, you fell short of your goals.
This is due to your investment has not yelled you return higher than the inflation. I call these activity zero. These are the activities which waste your time and money and get you nothing in return.
#1. Bank fixed deposits
Traditionally we park/invest our saving in either bank deposits or postal scheme. This secures us from the market risk and provides us with assured returns. There is a thumb rule that, if a product is secure it may not be liquid or it may give lower returns. Here as an investor, you need to assess your risk profile as to why you want to go for bank deposits. In India, most investors compromise on returns over risk. To me, a fixed deposit is a dead product and has many disadvantages which you should know before parking your savings.
Fix deposits can’t beat inflation
Bank deposits rates are normally parallel to the inflation rate. But it is proven that the post-tax rates are lower than the inflation. If you have parked your money in bank deposits for your long-term goals like children’s education or retirement, then it is inevitable that you miss these goals. On the other hand, the cost of education and health care is increasing at a rapid speed. So to beat inflation, you have to take a calculated risk.
Income is taxable
In India, interest earned above 10k is taxable as per your tax slab. This means that interest earned on bank deposits returns are taxable if it is higher than 10k(which is most likely in the case). This reduces your overall return. Net return on investment will be lesser by the amount of tax payable on it. If you fall into higher tax slab than you seriously need to think before you put your money into fix deposits. I would prefer to pay tax and invest residue amount into equity for higher returns which will not only compensate the tax I paid but also yelled me higher returns in long run.
Liquidity has its own cost
No doubt you can withdraw your money from the fix deposits at any time during the tenure. But withdrawal from the fixed deposit cost you. You will not get the same rate of interest as committed by the bank at the time of commencement of deposit.
Bank deposits are not fully secured
You should know that only Rs. 1 lac of your savings is insured by the bank. As an investor, you should know the risk of parking your money in the bank. I am not saying that it’s not safe, but with rising concern of NPA in some big banks make me think cynical. In India, Govt. bank’s NPA is way high than the private sector banks. On the other side Govt. banks are enticing its customers for bank deposit by giving half to one percent higher than the private sector banks. I have seen most of the people comparing interest rates before deciding which bank to choose for parking money. Taking decision based on this additional ½% to 1% can prove fatal.
Parking your saved money into bank fix deposits is a zero-sum game. Sorry, I am wrong, it’s a negative sum game. You will get negative returns on the bank deposits. – Activity zero, no! no! its Activity Negative rather.
“In investing, what is comfortable is rarely profitable.” – Robert Arnott
#2. National Pension Scheme(NPS)
National Pension Scheme is a voluntary contribution retirement scheme design to help an individual for systematic saving during their employment tenure. It inculcates the habit of saving for retirement and provide regular income during the retirement years. So investment like NPS is good enough for retirement planning or not? Let’s understand the features of the scheme to find out.
Funds in NPS gets locked for a long period as it is retirement focused investment scheme. In the scheme, till you get retire you keep on investing money into it which accumulates. After retirement, it gives you an annuity. After retirement, the payout happens in two ways: lump sum withdrawal of max 60% of the corpus and secondly, annuity starts on the remaining 40% for the lifetime. So 40% of your contribution which you made until the age of 60 will not be given you back. It’s only the annuity one receives during the lifetime. You cannot withdraw funds unlike EPF, PPF till the age of 60 years. And after 60 years you will get only 60% of the corpus. That too taxable!
At the age of 60, only 60% of the corpus amount can be withdrawn. Remaining 40% will come to you as an annuity. And on this 60% withdrawal amount, only 40% is tax-free. This means one has to pay tax on the remaining 20% of the corpus which he/she gets after retirement. To avoid tax you need to delay withdrawals, resulting in lesser withdrawal or cash flow crunch when you need it most. 40% of the corpus will be unavailable to you for the entire lifetime. What is the point of investing money which you will not get back? Can somebody tell me the investment avenue which is riskier than NPS? – I rest my case!
Long term, but no full equity option
NPS, though it’s a long-term investment scheme is the conservative scheme by giving you an option of up to 50% of investment into equity, rest 50% is into debt scheme. It’s proven by several studies that equity gives you best returns among debt, gold, real estate in the long term but still, this scheme offers only half of the portion to be invested in equity. If you ask me, I would prefer to invest in bank FD over NPS scheme. (at least in bank FD, I will get liquidity option).
40% corpus is gone
As mentioned above, 40% of the corpus is non-refundable. You have to purchase an annuity plan immediately. The corpus you pay for this plan is never returned to you. Moreover, the annuity returns across various pension option are at around 6% per annum. Such low returns will hardly enough to beat inflation. So higher chances are there that you lose your money in both ways. (40% is gone as the non-refundable and low return of 6% as an annuity) – Activity Zero
An annuity can provide you only baseline support but is not enough to survive for your retirement years. A corpus created through a mix of mutual funds can help you to create a substantial amount of money to survive in your later years.
#3. Life Insurance (LIC) Policy
Life insurance corporation (LIC) is India’s biggest investment firm. The insurance policy that LIC sells is basically an investment plan with a flavor of insurance. Data tells us that LIC is terrible in terms of managing public money. A major portion of the money collected from the public as insurance premium is invested in stocks and bonds. The irony is most of the policyholders doesn’t even know that they are actually investors. (feels good no?) – I have a bad news for you as well. The returns on investment for LIC for the last 10 years is 6.7% only.(lesser than inflation). Terrible job here in LIC. Is it good to go for LIC policy? Let’s break it down.
Low return on investment
As mentioned above, 10 years average returns on investment for LIC is just 6.7% which is nothing for the biggest investment company in India. It’s performing even worse than the government bonds which is at 7.9%. The thumb rule is – an investment firm should be able to generate returns higher than the government bond at least. It should be able to beat inflation also. This tells us the investment management capabilities of LIC is very poor. It indicates that LIC is not actively managing money.
Higher Government interference
Every now and then Government asks LIC to invest in public sector enterprise which is generally sick and avoided by other investors like you and me. If the market is bearish, govt. ask LIC to pump in money to generate liquidity in the market and create a false wave. If you see, LIC has major investments in public sector banks. These banks are sitting on the huge pile of NPA(non-performing assets). Why is LIC investing money in such banks? There is a regulation by SEBI that any mutual fund AMC cannot have more than 10% of stake in any company, why such a rule is not applicable to LIC?
There is a lock-in period termed as policy tenure(maturity), before that you cannot withdraw your money. If due to an emergency you want to stop/withdraw your money back then you will in shock to know that you will even not get your money which you have paid over the years as premium. Forget about returns on investment, you will not get your paid money back.
The great Indian social obligation
The LIC agent is mostly a known social person around you. It’s an obligation to buy a policy from the agent. Even if you know that you are not knowing the investment. The biggest catch here is there is no accountability as most of the plans are more than 20 years of tenure. So you can’t even confront agent for the return. The agents are trained to speak like ” Your returns will grow 4 times in 20 years, they will never talk about annualized returns. (Fact is most returns are 3.5 to 5%) it is never stated in papers and agent will excite you by quoting “Additional bonus” and stuff like that.
Never mix investment with endowment plan. If LIC policy can give you good returns then, entire India would be a rich nation.
You are better off putting your money somewhere else rather than buying LIC policy. If you want to save tax there are other tools like PPF. For the insurance cover, always go for term plan of any insurance company. What is the point in investing money in order to earn only 6-7% returns which can’t beat inflation? – Activity Zero