Sample this. You earn a return of six per cent per annum on savings account deposit today. This means that your money would grow from a Rs 100 to Rs 106 if you kept it in your savings account for a year. Say inflation stands at 7.5 per cent. This means that what you could buy for Rs 100 one year back, can now be bought at Rs 107.50. As a result, your real return (pre-tax returns minus inflation) is unfortunately negative. And you end up eroding your savings by Rs 1.50, by not beating the inflation rate. In this example, the real return is 6 per cent minus 7.5 per cent or negative 1.5 per cent.
If this were to happen to your money over a certain period of time or on a continuous basis, this is akin to termite eating into your furniture. And you realise it suddenly one day when the furniture gives way.
The main motive of investing should not be accumulating funds for future need. Unfortunately, that is what most identify investing with. But, it is prudent to understand that your investment should be able to beat inflation. And to be able to do so, you should earn real returns. This is important for your financial health. Otherwise, you will only keep accumulating funds.
| THE DEBT FUND FAMILY |
| Liquid funds |
| * Investment Period: 3-6 months |
| * Invests in: Debt instruments with a maturity of 91 days |
| * Advantages: Gives better returns than savings accounts, low interest rate and credit risk, helps dealing with equity market volatility |
| Ultra short-term funds |
| * Investment Period: 1 day to 3 months |
| * Invests in: Debt securities maturing in a year |
| *Advantages: Give higher returns than liquid funds, better for those who can tolerate volatility |
| Short-term funds |
| * Investment Period: 18 months to 2 years |
| * invests in: Debt securities maturing in over one year |
| * Advantages: Low to moderate interest rate risk |
| Income funds |
| * Investment Period: Over 2 years |
| * Advantages: For investors who want regular, steady income, gives better returns when interest rates soften |
| Gilt short-term funds |
| * Investment Period: 2-3 years |
| * Invests in: Varied medium- and long-term securities |
| * Advantages: Suitable for those who want safe instruments with zero default risk |
You also need to understand the difference between savings and investment. You cannot invest if you don’t save. Saving is income minus expenditure. Savings bank deposit is not an investment. A fixed deposit is. However, if you earn 8 per cent on a one-year fixed deposit, the real return is only 0.5 per cent (8 per cent minus 7.5 per cent).
For risk-taking investors, equities (either direct stocks or mutual funds) are advised as this avenue is a high growth instrument that can easily beat inflation. Equities, on an average, give 12-15 per cent returns annually. Till now, the highest inflation has ever gone is ten per cent in 2011, when the Reserve Bank of India had to step in by easing liquidity in the market to stem inflation. Therefore, equity investors have been lucky so far.
However, on the fixed income side or for risk averse investors, returns may have been a tad lower or at best, on par with inflation. So, the lucky ones may not have made money on their investment. But, some may have had to lose some capital.
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Hence, investing in avenues that beat inflation and generate positive real returns becomes even more important for such investors. Mutual funds can come to the rescue of the risk-averse investors, too as many of these investors are seen to be wary of this investment route. Just that, you need to understand that by virtue of being market-linked, mutual funds cannot assure returns unlike banks deposits. But, that does not make them very risky, these are safe instruments as they largely invest in government securities. And they work very well for different objectives for which you need money in future. But, do make sure to read the scheme information document before investing.
Debt mutual funds are more liquid and tax efficient when compares to its fixed deposit counterpart. Here’s some help -Liquid funds or money market funds are a strong contender to savings bank accounts. They invest in easily saleable fixed income securities like banks’ certificate of deposits and highly credit rated companies’ commercial papers maturing in 91 days. They offer excellent flexibility to get in and get out of the investment. You can withdraw, get the proceeds even the very next working day as long as you give the withdrawal instructions before 3 pm. Withdrawal, here, is as easy as from your bank account or giving instructions online. These offered 9.12 per cent in the past year.
Ultra short-term funds are called debt funds in the offer document and the fund manager is free to buy securities that mature in more than 91 days. But there is no compulsion to do the same. The volatility of returns is marginally higher than liquids funds as they invest in instruments with longer maturity. These have returned 9.39 per cent in the last one year.
Longer term investors should explore the fixed maturity plans (FMPs) route. As the name suggests, FMPs specify a date on which your investments will mature. On maturity, the money is debited to the bank account. FMPs come in varied tenures from 3 months to 3 years. Some FMPs only invest into banks’ certificate of deposits. The risks here are very low. These are also very tax efficient as it cuts across two financial years to give indexation benefit. FMPs have returned between 9 and 10 per cent in the last one year.
The writer is MD, iFAST Financial India