We understood the basic difference between Saving and Investing in the first article under the Investment Basics series, now let us continue the series with next post – Investment Basics: Cash Savings and Returns.
If you have not gone through the previous post, please visit: Investment Basics: Saving vs. Investing
In a continuation of the ongoing Investment Basics series at “The Wealth Ved”, now we will try to understand the meaning of Cash savings and the real returns on cash savings with Indian perspective.
While saving or investing, we expect that our money should at-least grow faster than general rise in the price (inflation). This is a valid approach because we all know that Inflation is evil. To put things into perspective, inflation erodes the value of money. It reduces what can be bought with Rs. 100 or Rs. 500 over time.
It is easier said than done to beat inflation and grow money. In India, cash savings have lost value in last decade if we include the impact of inflation.
Let us understand this with the chart below:
Surprisingly, in last decade only 1 year had positive inflation adjusted returns if money saved in bank saving account. The real returns (inflation adjusted returns) ranged from -7.7% to +1% in last decade in India.
How do we calculate the inflation adjusted returns?
The Reserve Bank of India deregularized the saving account interest rates in 2011 and since last few years, many private banks such as IndusInd, Yes and Kotak etc. have been offering 4%-6% interest rate on bank savings accounts.
Despite the Reserve Bank of India continuously raising base interest rates since 2017, the banks have not been increasing the saving bank account interest rates. A few banks have raised their fixed deposit and term deposit rates but saving bank account rates have stayed the same since last decade.
By looking at the average interest rates on cash savings, as offered by major Indian banks, we see that they have not surpassed inflation in last 9 out of 10 years. For most of the past decade, cash savings have typically lost value after we factor in the effect of rising prices.
Between 1 September 2008 and 30 August 2018, real interest rates – after adjusting CPI – averaged minus 3.8% a year. Yes, -3.8%.
This means Rs. 10,000, saved in an average instant access bank account a decade ago, would be worth just Rs. 6,788 today after the effects of inflation.
What causes inflation?
There are many influences the inflation such as rising oil and other commodities prices and demand-supply mismatch. Stronger economic growth also impacts inflation as the rising demand puts additional pressure on supply, leading to price increase. Other factors such as money supply, higher production costs, interest rate decisions, taxes and wage growth also impacts the inflation/.
What do we do now?
Well, cash has its place in every financial plan due to its instant availability and contingency requirements. The saving bank accounts are also insured by the Deposit Insurance and Credit Guarantee Corporation up to Rs. 1 lakh.
Thus keeping a cash buffer offers sense of security and zero risk up to Rs. 1 lakh. However. At the same time it is very important to remember that relying excessively on cash savings could prevent you from achieving your long-term financial aspirations.
Is there any other product than Saving Bank Account which can be used to park the cash?
Managing cash savings smartly becomes very important during high inflation and interest received in savings account fails to beat the inflation rate. Savings bank account is the stepping stone to achieve the financial freedom as it makes savings a habit, however many other cash-like products are also available in the market in form of debt mutual funds.
These short duration mutual funds offer a little extra returns compared to the bank savings account by investing in treasury bills, commercial paper, etc. which mature within a period of 91 days.
One should also understand that liquid funds are not completely risk-free as sudden downgrade in the credit rating of underlying security might trigger a fall in Net Asset Value (NAV), impacting the returns. However short maturity period of 91 days prevents the fund NAV from getting impacted too much by the underlying asset price fluctuations.
Many consider that liquid funds offer efficient channel to park the surplus fund or create emergency fund as these funds generally have low risk and high returns compared to bank savings account. With zero exit load structure, liquid fund offer flexibility of withdrawal as per convenience.
What should cash savers do?
I have developed a 4 point checklist for the Cash Savers:
- Do not forget that a solid emergency fund is absolutely necessary and saving for that is mandatory
- Always save your cash in bank where savings interest rates and maximum
- Always make sure that you are not over relying on your cash savings
- Consider liquid and ultra-short mutual funds as an alternative options to save money
I generally keep my emergency funds (6 months of expenses) in a 60%-40% mix of savings bank account and liquid funds. The saving account gives me instant access to the money if required in urgency whereas the liquid fund offers a little extra gain with money availability in a very short notice.
Please consult your personal financial advisor before taking any financial decision.