18 ways to cut costs

THE basic needs of man are food, clothing, shelter and entertainment. Today, most of us have graduated from needs to luxuries. When the newspaper headlines were screaming inflation at 11.9 per cent, it became a topic of worry. Today, the challenges are not just high standard of living, high commodity prices, it’s job loss too. How do you deal with meeting your basic requirements with less means to buy them?

While eating just one meal a day is good for Yogis and is a nice way to cut down costs, that is not what I’m suggesting. Instead, Try something simpler.

1. Eat at home
Eating out can be expensive. If you are spending Rs 200 on eating out compared to Rs 50 at home, you would be surprised to know the kind of amount you are spending. A systematic investment plan of Rs 150 (200-50) a day saved for 30 years can give you returns in excess of Rs 5 crore!
 
2. Know what you are buying
Plan your shopping. If you fill your cart with everything that catches your eye, chances are you will be spending a lot more. Instead, plan your meals for the week ahead and make careful note of what you need to buy. Purchase only the items on the list, avoid the rest.

3. Wear your blinkers
Stores are designed to make you go through a long walk to reach for your most basic items. Reason — you can tricked into buying what you don’t really need. Most basic commodities are found towards the end of the store. So, the next time you go shopping, you could skip the other outlets and move towards your destination.

4. Shop on a full stomach
When you’re hungry and shopping, you may end up buying lot of things that look like food! You might also pick up what you don’t really need. On the other hand, you can easily avoid unnecessary shopping when you’re a full stomach.

6. Do you really need bottled water?
You can take a bottle of water when leaving home rather than buying when you’re out.

7. Shop sans the kids
Hungry, tired, cranky kids increase the amount of time it takes to get your shopping done. Kids can really bug you into buying things which are bad for your health and for your purse. Leave them at home when you go out shopping.

8. Buy in bulk
You can save a significant amount of money if buying in bulk. Pay attention to the prices and pick up the family size package if the per unit cost is lower. However, you need to realise that bulk buying has a dark side too! If you are not a big user of any particular product, it could mean wastage.

9. Use store reward cards
If you visit a particular store often, you can sign up for their reward card. In some cases, stores raise their prices when they offer reward cards, and without the card your bill will certainly be higher. If the card offers other benefits, such as a preferred (or free) parking, free schemes, etc., be sure to maximize your benefits before they expire.

10. Buy local products
For instance fruits. Whenever I step into a big branded store, I was pushed into buying ‘American grapes’. I fell for it once, and realized only on billing that it was Rs 400 a kg! The Indian variety is normally available for Rs 40. Locally grown or produced food is often available at a cheaper price because you don’t pay for long transportation costs. Stick to them.

11. Choose unbranded goods
There is a huge cost difference between a branded product and an unbranded one. Even in case of ‘expensive’ items like dry-fruits, if you buy it from a wholesale-retail shop you will find a 20 per cent price difference. Some branded foods like cornflakes, are more expensive than dry fruits on a per kilogram basis. If you thought potatoes were selling at Rs 12 a kg, you are correct, but when it gets converted to branded chips, it becomes a little expensive, about Rs 300 a kg!

12. Men are bad shoppers
It is not so much of a gender issue. But the truth is men do not have much patience and that shows while shopping. So, if you are a man, realize that shops know and understand this. So things are arranged in such a way that when you are in a hurry you will end up buying the most expensive items. Look around to find cheaper items.

13. Compare prices and stores
I personally do not compare prices and stores but my wife has a degree in this! She knows which shop is good to buy vegetables, branded goods, unbranded goods. And she plans her shopping accordingly.

14. Shop in sales offers
In India, September to December months are considered as ‘festive season’. This is the time when most of the shopping happens. Surprisingly, Hindus, Muslims and Christians have some festivals for which they buy new clothes during this period. So, stores generally keep a pre-festive sale in July-August and a post-festive offer in January. Use these sales to build your wardrobe. You can even get good deals!

15. Shop less frequently
The lesser the number of trips to the shop, the lesser you will buy! So, if you are making more trips to the store, it is time you reduced them.

16. Pay in cash
When you buy your day-to-day requirements with your credit card, you run the risk of paying your credit card dues late. So, for all the saving you have been doing, you may give it away in the form of interest. Cash is a good option. Besides, you tend to be more careful when making cash payments.

17. Check your bill
You should check all the statements which have a financial implication be it your credit card statement, mutual fund statement or your groceries bill. Scanners are fine, but there are possibilities of mistakes. So, you must see the bill before you pay.

18. Buy leather goods in monsoon and umbrellas in winter!
Buying goods in off season will cost you less. If it’s monsoon, check out for sale on leather goods and umbrellas in winter.

Others are hardselling certain loans. If the loan is available easily or the interest rate is low, it’s not reason enough to borrow. Gaurav Rastogi lists out the new dos and don’ts of borrowing

The tumultuous changes in the economic landscape over the past two years have rewritten many canons of financial prudence. Though the basic rule of borrowing remains the same take only as much as you can repay comfortably some finer aspects of lending have changed. To begin with, there is the new RBI guideline on base rate as opposed to the prime lending rate used by banks. Some lenders have become more cautious after the subprime fiasco in the US and, hence, borrowers need to know how to get past the barriers. Others are hardselling certain loans. If the loan is available easily or the interest rate is low, it’s not reason enough to borrow. Rakesh Rai lists out the new dos and don’ts of borrowing.

Teaser rates: Avoid the trap
Banks try to attract new customers by offering them loans at teaser rates that are lower than those paid by their existing customers. Before you fall for the gimmick, keep in mind that the teaser rate is for a limited period. After a year, the loan reverts to the prevailing rate of interest. This also means that borrowers might be lured into taking loans they can’t afford. As the RBI states: “There are concerns about the borrowers’ ability to service such loans if interest rates were to rise sharply.” If the rates rise after you take the loan, you could be faced with an extended loan tenure or a fatter EMI. Either way, it will strain your finances.

Collateral: Don’t give more to take more
Non-performing assets, or bad debts, are a banker’s worst nightmare and the situation became particularly grim after the 2008 crash. This is why banks are now insisting on collaterals when they give a loan. A bank may also ask you to open an account or make a fixed deposit. Some offer loans or a line of credit against mutual fund units, shares, government securities, gold, real estate, even your car. If the amount you plan to borrow is not big, it may not be worthwhile to go through all the paperwork required to take the loan. It would make more sense to break a fixed deposit at a marginal cost and use the proceeds for your needs rather than borrow against it.

Credit cards: No longer free for life
The piece of plastic in your wallet can get you an interestfree loan every month. If you pay your entire credit card bill by the due date, you get up to 45 days of free credit. However, it would be considered truly free if you weren’t paying the annual fee. Now, credit cards issuers are cutting down on lifetime free card offers. ICICI Bank, the country’s largest private sector bank, recently withdrew its lifetime free card scheme, which was introduced in August 2005. This forced other banks to follow suit. After the economic slowdown, banks have begun to shrink their credit card portfolios. So, if you plan to go for another credit card, keep in mind the membership fee that you will be required to shell out every year. Some credit card issuers, such as Axis Bank, have been targeting only the existing customers.

Tax: The DTC disadvantage
While most people buy houses to live in them or as investments, there are others who are guided primarily by tax benefits. There are instances where people have taken home loans just to save tax. The first thing to be kept in mind is that the tax benefits on the interest payable on a home loan are only meant to reduce the borrower’s burden. For every Rs 100 you pay in interest on a home loan, the Income Tax Department gives you a deduction of Rs 10-30, depending on your income slab. The point is that you still spend Rs 70-90.Another compelling reason for you not to take a home loan to avail of tax benefits is that the Direct Taxes Code, which is scheduled to come into effect from 1 April 2011, proposes to do away with all deductions, including those offered to home loans under Section 24B. So, you might just end up with a long-term liability without the tax benefits.

IPOs: Never borrow to invest
The Application Supported by Blocked Amount (ASBA) facility, introduced by market regulator Sebi, couldn’t have been more timely. Several IPOs are in the pipeline and ASBA will allow small investors to participate without having to block large sums of money. Under ASBA, when you apply for an IPO, the money stays in your bank account, but is blocked. It is debited only if you are allotted shares. If no shares are allotted, it’s unblocked immediately. However, most brokers cannot provide the ASBA facility. Instead, they offer to part-finance your IPO application at interest rates ranging from 15-18 per cent. The stocks in your portfolio are used as collateral. Now comes the tricky part. In case you default in repayment, the broker can liquidate your shares to realise his debt. This is a recipe for disaster, as many investors discovered in 2008. When the markets crashed, brokers offloaded shares kept as collateral at rock bottom prices. Moral of the story: don’t invest borrowed funds in IPOs.

Loans: Update records
Many borrowers would like to repay their loans as soon as possible. Since all loans are linked to your credit history, you should be careful while settling a loan with your bank. Banks are required to update their borrowers’ records with the Credit Information Bureau of India (Cibil) regularly, and once you have cleared your loan, your record in Cibil should indicate this. However, some banks, in case of compromise settlements, say, on credit cards, report it as ‘written off’ while updating the records with the bureau. This may not affect you immediately, but when you approach another bank for a loan, your application might be rejected due to the unfavourable credit history. To avoid this, make sure that you always obtain a no-dues certificate from the lender, which clearly states that you don’t owe them any money and the account has been satisfactorily closed. Cibil looks at a range of transactions, including utility bill payments, credit card bills and other loans, to assess the credit history

When you earn money, you can either spend it or invest it. Even when you don’t have enough money, you can borrow and spend.

But how are earning, saving, investing, loans, credit and debt related? Let’s find out.

So, let’s start with the most fundamental thing: Earning money!

Income or Earning Money

This is a very simple, basic thing – you have to earn in order to be able to spend!

You can earn money through a recurring source of income (monthly salary, or profits from business), or through more irregular sources, like bonuses, capital gains (by selling shares or a house), etc.

Current Consumption

Let’s say you earn Rs. 20,000 per month.

Out of this, say Rs. 5,000 goes towards rent, and Rs. 10,000 goes towards essentials like grocery, clothes, etc. This is your non-discretionary expense – these are essential expenses, and you do not have an option to not spend these amounts.

Since you spend this money as soon as you earn it, let’s call it your current consumption.

Now, you are left with Rs. 5,000 per month. This is, in a way, extra – something that is left after meeting all compulsory costs.

You have an option to spend it as well: You can buy something for your house, spend it on a vacation, or give a gift to your spouse!

The avenues are countless. And if you do that, again, you would be consuming this money as soon as you earn it. Thus, this would also be your current consumption.

Future Consumption

Another option for you is to save this money and invest it.

This means that instead of using the money now, you expect to grow it and use it for future consumption. You are postponing your consumption.

You are sacrificing the current consumption with the expectation of growing the money and be able to use it better in the future.

You can invest the money in a bank fixed deposit (FD), bonds, post office schemes, stock markets, anywhere – the objective remains the same: to grow the money so that in the future, you can achieve more from it compared to what you can get from it now.

In our example, Rs. 5,000 invested today can grow into Rs. 15,000 in 5 years (say, if you invest in equities) – and then, you can use it to buy something much better than what you can buy for Rs. 5,000 today.

(Investment in shares / equities gives the best long term returns. Read “Stocks - The winning bet for the long term” and “Equity Investment is Risk Free – Here’s the Proof” for more)

So, this is saving or investing: You sacrifice current consumption in order to get a better outcome from the money in the future. In a way, you pay for your future spending from your current income.

Drawing from the future

Debt / credit / loan are direct opposites of future consumption. When you take a loan, you spend the money right now, knowing that you would pay for it from your future income.

Let’s revisit our example. You want to buy a motorcycle. You only have Rs. 5,000, and the bike you want to purchase costs Rs. 45,000. You can wait for 9 months to save up this amount, or you can buy the bike today by taking a loan.

That way, you would get Rs. 45,000 today, and you would be able to buy the bike right away. And, you can pay Rs. 5,000 towards it (as EMI) for 10 or 11 months.

Since you know you would be earning a steady income in the future, you can draw form the future income to buy things today. Thus, when you buy things on credit or through a loan, you pay for your current spending from your future income.

You get to spend the money that you have not even earned – but there is a price you have to pay. The banks or financial institutions that lend you money or give you credit charge extra money from you in the form of interest.

It’s a price you pay for drawing from your future income.

What is the optimal way?

It is traditional Indian belief that you should not live beyond your means. (Sayings like “Jitni chadar ho, utne hi pair pasarne chahiye” testify this!)

I tend to agree with it – you shouldn’t buy something on loan unless absolutely necessary, or unless it is an appreciating asset like a house.

(Read more about the benefits of buying a house in “Settle early in life - buy a home when young”)

So, the choice remains between current consumption and investing for future consumption.

You work very hard to earn money, and you should enjoy it as well. Thus, some current consumption is definitely appropriate.

But at the same time, through investments, you can grow your money to buy even better things in the future. Thus, you should keep aside some of your disposable income for regular saving and investments.

Happy investing!

Monika Arora , 26, a software professional, was looking to invest Rs 50,000. And while friends and colleagues suggested a plethora of stocks or mutual fund schemes, she wasn’t feeling very confident about taking a decision on their advice.

While hunting for professional financial advisors on the Net, she came across several names. On approaching one, she was handed a big list of MF schemes and returns. “You can invest in any one of them,” the advisor said.

Once she had selected a scheme, the advisor invested the entire Rs 50,000 in it. When she sought to divide the money between two-three schemes, the advice was that the money was too little to be split.

Three months later, the advisor called her to say there was a new fund offering (NFO), which was rather promising. And since Rs 50,000 had grown to Rs 60,000, she could invest some part of it in this scheme. “You will get more units, as the net asset value (NAV) is only Rs 10,” the advisor said. Six months later, he again asked her to invest in another NFO.

At the end of the year, while Monika’s money was divided in three schemes, it had grown by only 25 per cent. In comparison, the stock market had risen more than 50 per cent during the year. On enquiring, she was told that she had to pay a short-term capital gains tax of 15 per cent twice, while moving money from one scheme to another.

Monika’s  case is not isolated. Many financial advisors hurt your finances by misleading you. Making you move money several times during the year is one way. They do it because they are paid higher commissions for promoting these schemes.

“If the advisor asks you to exit an existing infrastructure scheme for a new one, it is clear that he is taking you for a ride, because the new scheme will also invest in the same companies,” said  Gaurav Rastogi, Founder, Ask4money.com

Similarly, many sell unit-linked insurance plans when you are looking to buy a term plan or MF. The tell-tale signals are when a financial advisor offers to pay the first premium for an insurance plan or gives you money back for investing in a particular scheme.

“In such cases, be sure that he is getting an exorbitant commission, and it is from your investment only,” said Gaurav Rastogi, Founder, Ask4Money.com. In other words, the recommendations are being made to earn the commission, and your needs are not being addressed.

Also, if the stock or entire portfolio is being churned too often (three-four times a year) under the guise of ‘rebalancing’, it means your tax outgo is becoming higher. So, how does one select a financial advisor? “There is no clear answer,” said Gaurav Rastogi, Founder, Ask4money.com

But having basic knowledge before investing is important. At least, it helps to ask the right questions. To start, check the advisor’s qualifications. The advisors should preferably be certified by Association of Mutual Fund Industry (Amfi) or Insurance Regulatory and Development Authority (Irda). “These certifications ensure the advisor knows about products and is in a position to meet the client’s needs,” said Gaurav Rastogi, Founder, Ask4money.com

Also, rely on well-known advisory companies, compliant with regulatory norms. Advisors who have experienced at least two market cycles are likely to have reliable perspective.

Always question the advisor’s recommendations, because it is important to know how a product will benefit you, based on your goals and risk profile. “A need-based analysis and risk profile are very important, because they are highly personalised. An advisor cannot recommend a one-size, all-fit product to each client,” added Rastogi

What’s the first thing that comes to your mind when you think of being rich?

In the last 10 days, we have conducted personalized Financial Planning Workshops for over 150 clients, and here are 5 most popular responses of the attendees:

• Not have to worry about money ever again
• Freedom to spend as I like
• Early retirement on my own terms
• Ability to take a holiday anytime and anywhere
• Financial security

Numerous other answers were just alternative interpretations around these above themes. The common thread is that being rich is about having the financial freedom and flexibility to do what you want without feeling constrained

As financial advisors, we strongly believe that one does not need a high salary to be rich, but its what you do with the salary you get or the income you generate. One could have a very high income, yet one might be so indebted because of one’s lifestyle or financial habits, that one’s net worth might not show any sign of being rich.

So, whats the best course of action to get rich when you get your monthly income? Its pretty simple really. Its all about the discipline of taking a share of your income to build assets that can generate income. His can be an alternative source to your primary source of income. What you earn from this alternative source can be used to create still further assets. Within a short period of a few years, you can get into the virtuous cycle of generating lots of additional sources of income.

Rather than spend from your salary, if you invest this salary and then spend the income generated from these investments, your salary can continually be used to facilitate the process of compounding of your capital. Your investment income can make you feel and act rich by giving you financial freedom and flexibility that is not limited to what you can achieve with your salary alone.

Getting into this virtuous cycle might seem hard, but all it requires is some discipline on your part. Books such as Rich Dad, Poor Dad have popularized the above idea in ways that are easy to understand and implement. Look around you and you will see colleagues at work who earn as much as you do, but might have more financial freedom because they have followed the ideas promoted in these self-help books.

So next time you get handed a pay cheque ask yourself what is the best way to use this money if you want to get rich. Its all in your hands!

As consumers, we have all seen advertising about cheap home loans. These are designed to invite the customer into believing that this is the best offer in the market. However, cheapest home loans don’t necessarily mean the best home loans.

The following is a guide to recognizing why cheapest loans might not be the best option for you.

• Interest rate and EMI is just one aspect of the loan: Recognize that cheap home loans make for attractive headlines, but the interest rate is only one aspect of a housing loan. Be extra cautious and understand if there are other strings attached or not. For instance, the sub-prime crisis in the US is partly the result of the aggressive advertising of cheap loans to customers who ignored analyzing other important aspects of the home loan.
• Check for hidden costs:It will be impossible for a lender to charge a rate which is dramatically lower than other lenders. So, if a lender is charging below market rates, chances are that this will be made up for in some charges, which sometimes are not obvious at the time of the loan. Charges might often include:
  • Application fees
  • Appraisal fees
  • Administration charges
  • Pre-payment penalties and foreclosure charges
  • Late penalty fees
  • Technical fees

Often the sum total of these charges might end up making you worse off by taking a cheap loan, compared to taking a market-rate loan where the lender waives some of these charges for you. Remember to always calculate the fully-loaded costs of the loan.

• Understand what terms yous are signing up for: Always understand the various terms, conditions and clauses of your loan. Ask for explanations if something is unclear. Specifically, clarify whether your cheap loan might get re-priced during the life of the loan without your consent. You don’t want to be surprised to see your interest rate and EMI shoot up without any notice.
• Compare service levels and costs across the life of the loan: Don’t compare only the interest rates. Also consider the overall cost of the loan including all processing fees. Service levels can vary significantly. Check with your family/friends/colleagues about their experiences of dealing with the cheap home loan lender. Are you confident that your loan will be disbursed on time and that their will be no new obstacles that can make the loan unattractive.
• Flexibility: Some loans may genuinely have cheaper rates and offer low processing fees. However, they might come with the inconvenience of offering absolutely no flexibility. For instance, if you want to pre-pay or to refinance the loan, you might not be given that flexibility at all.

As always, look closely before you jump in to get the cheapest loan. Don’t get too swayed by the low rates. You can compare home loans in India at Ask4money.com and find the best home loan for yourself.

Things to remember

• Interest costs are only component of a home loan cost – don’t ignore all the other costs like associated charges and fees.
• Understand all the terms and conditions, especially whether any term can be modified without your consent or knowledge.
• If something is too good to be true, it probably isn’t. So don’t believe in the hype about cheap home loans. Analyze, compare and then make a decision.

When you take a loan from a bank or a housing finance company, its unlikely that the bank will offer you 100% of the value of the property. Rather, they offer you a loan for only part of the value of the property. In the current economic climate, this “loan to value” or LTV is around 85%, i.e., you have to find the 15% of the value of your purchase on your own. LTV is one assessment the lender makes in offering you a home loan.

Here are 3 more points you must know about LTV?

Firstly, that the LTV depends upon the lender’s valuation of your home, and not yours. This is especially important when you are buying a home in the resale market, for which there is no objective barometer of what the value of the home should be. So, for instance, you might be buying a house for Rs 60 lakhs, but the lender’s surveyor’s might value the house for underwriting purposes for only Rs 50 lakhs and will give you a loan for Rs 42.50 lakhs only, and you will have to find the balance of Rs 17.50 lakhs through other sources. Of course, it the transaction value is less than the lender’s appraised value, you will get a loan on the transaction value.

Secondly, if the lender sees you as a high-risk borrower, i.e., they do not have full comfort in your ability to service the loan, they might reduce the LTV and demand that you pay a higher amount of the value of the house. For instance, instead of offering you the typical 85% loan to value, they might insist that their contribution can only be 70%, in which case you have to find the balance on your own.

Finally, if you want a high LTV and the lender agrees to give it to you, its likely that you will be expected to pay a higher rate of interest and as a result a higher loan EMI. You need to be comfortable that this is a burden you are willing to take upon yourself.

LTV is one way the lender is going to assess the risk of lending to you. Its not meant to comprehensive or the sole criteria. To improve your case, make sure you have all the necessary documents to support a higher LTV for the cheapest home loan rate

Starting July 1, all banks in India will be moving to a “base rate” regime. What does this mean for you and how does it affect your existing borrowings? Here we help clarify some of these questions.

What is the base rate?

When you borrow money to buy a house or car or electrical appliance, there is an interest rate that you have to pay to the lender. The base rate is the minimum rate that a bank will lend money at. Think of it as a floor below which RBI will not allow banks to lend to you.

Previously, banks used to price the loans they offered you on a complicated system called benchmark prime lending rate (BPLR). Each bank has its own BPLR methodology which made it difficult for borrowers to compare rates across banks. Now, with the base rate in place, it will be easier for all of us to compare across banks and to get a more transparent sense of how the interest rate for the loan is being arrived at.

Is my interest rate going to be cheaper? Will my EMI change?

The most important thing to keep in mind is that the cost of money is not changing, i.e., if your car loan cost about 12% or home loan cost 9%, this rate of interest charged to you will be no different going forward. Its just that the method used to arrive at this will be more clear to you. So, interest rates aren’t coming down as a result of this base rate implementation.

Following on from this, your EMI on an existing loan is also not going to change. You will continue to pay whatever you were paying up to last month in future months as well.

Should I change to a bank with a lower base rate?

Like we said above, the cost of money is not changing. Most banks will continue to charge you a very similar rate of interest as they did before. Just because one bank has a base rate of 7.5% and another has a rate of 8% does not mean you should switch to the bank with the lower rate. On top of this base rate will be added an additional amount of interest that they bank will charge you to cover its cost of doing business with you, and some compensation for the risk its taking in lending to you. So, after all these additions, its unlikely that the lending rate that a bank will be charging to you will be any different to the rate being charged by your current bank.

You will see no major advantage to shifting from one bank to another.

How does the base rate affect my pre-existing loan?

Nothing is going to change for existing loans. They will continue as is. Like we mentioned above, interest rates aren’t changing in the economy. However, when your loan comes up for renewal, then it will be priced using the base rate formula.

Will the base rate remain fixed forever?

No, the RBI has given guidelines to banks to adjust their base rates depending upon the prevailing market conditions and interest rate policies. Expect to see banks update their base rates every few months if that is required. Banks will then communicate this to all their clients.

How do you decide whether to use your debit card or your credit card when you pay a bill at a retail shop, restaurant or any other establishment? Do you know what is the better thing to do? Here we give you some simple background to help you decide which form of plastic is best.

Debit cards are linked to your current or savings account. When you pay using your debit card, you are using your own money to pay. Credit cards, on the other hand, are a quick way you can get a loan from the card issuer to facilitate your purchase. Rather than the amount being debited from your account immediately, you get a statement at the end of the month, and are expected to settle your outstanding balance within the specified deadline, failing which you are liable to pay very expensive fees and penalties.

Personally, we have a preference for Debit cards because you know your spending limits and you are likely not to stretch yourself too far - you are forced to limit your spending to the amount of funds that you have in your account.

However, there might be times when you don’t have enough money in your account, and need the short-term funding to make a purchase before your paycheck. At such times, using a Credit card to pay is justified. But you must understand that the outstanding amount must be paid in full and on time when your statement arrives. Just because you have spent on your Credit card, does not mean that you don’t have to fund the payment. Somebody gave you a loan for it, and you must pay the loan back. If you don’t or you get delayed, the lender will charge you rates of interest that can be close to >40% per annum. Compare that to a personal loan of around 18% or home loans at 10% and you know that spending on credit cards can be very expensive.

Credit cards occasionally come with attractive features like loyalty points for rupees spent on the card and soft benefits available to card holders. However, these are worth nothing if you are in default of your repayments.

Remember, its prudent to live within one’s means, and in that regard the discipline of spending using one’s Debit card is a good one. Use your credit card only when you are confident that you have the capacity to repay your dues.

Can you find anyone who has become wealthy by leaving his or her money in the bank or an FD? If you want to create wealth, you must move away from this mentality of thinking that a savings account or an FD is the best home for your money.

Much has been made of the so-called comparison between mutual funds and ULIPs in the past few months. Our opinion is that the public debate on these two investment options misses the bigger point. The reality is that the bulk of the household savings for Indian families is tied up in bank accounts earning 3.5% interest and in FDs, both of which are highly inefficient investment options for wealth creation. Add to this the announcement this week that inflation has now touched double digit levels, and its an even scarier thought that most of us still prefer to leave our money in a bank, rather than in instruments that are higher yielding, be they equity mutual funds or ULIPs.

So the real debate should be whether families in their effort to create wealth are making a mistake in leaving their money in the bank vs. choosing to invest through instruments like mutual funds and ULIPs that offer a reasonable prospect of better long-term returns.

Mutual Funds vs. ULIPs - no big deal

Call it a turf war or clash of regulators, frankly in the long run it’s not a big deal from the end customer’s perspective. Whether its SEBI or IRDA, consumers should feel comfortable and secure that there is a regulator who is mandated to look after their interests.

Every investment instrument has pros and cons. We challenge you to find one that is perfect. So, there will always be promoters or detractors of both mutual funds and ULIPs. Objectively speaking, however, there is a better chance of you being able to meet your long-term financial goals through equity mutual funds and/or a ULIP than the default option for most Indians, which is to leave money in the bank.

Almost every one of us will have one of the following goals that require a substantial amount of money in the future: funding our graduate education, marriage, house purchase, taking care of children’s financial needs, funding their education and marriage, being adequately funded towards our own retirement.

Experience from all over the world has shown that our salaries are not enough to fund these goals. We need to invest into the capital markets, subject to our risk taking capacity, to take advantage of the compounding of capital, i.e., money that creates more money. No lesser authority than Albert Einstein remarked, “compounding is the 8th wonder of the world because it allows for the systematic accumulation of wealth”.

The advantage of equity mutual funds and ULIPs is that they are instruments that offer you a better rate of compounding for your capital than cash lying in the bank, and thereby provide a better chance of creating wealth in the long run.

Savings Accounts and FDs - bad deal for wealth creation

Let’s make ourselves clear. Savings accounts and FDs have a purpose and we cannot over generalize and make a blanket statement that they are bad instruments. However, when it comes to wealth creation they are not good instruments for you to invest through. We will show you why.

First of all, a savings account earns you a mere 3.5% interest rate, a level that is fixed arbitrarily. Similarly, a fixed deposit contractually fixes the rate of return at the start date of your deposit, and you cannot earn more than what you signed up for, even if interest rates in the markets were to rise. Compare this to a return that the equity market can earn you. History and experience of equity markets from around the world suggests that in the long-term equity markets are likely to “compound your capital” at approximately 12% per annum. Compared to this, a 3.5% savings account return just does not match up.

Secondly, savings accounts and FDs are highly tax inefficient. Any interest you earn through these will be taxable in your hands as income, and you will be liable to pay tax on this income. Compare this to equity mutual funds and ULIPs where at least for the time being until the new direct tax code is implemented you pay zero taxes on your gains if you hold these instruments for the long-term. And, if you invest into an equity linked savings scheme (ELSS mutual fund) you might find this an even more tax efficient investment than a regular mutual fund.

Finally, and perhaps most crucially, by leaving your money in a bank or an FD, you are losing the purchasing power of that money. Because you are earning a fixed return through these instruments, these instruments cannot offset the corrosive effect of inflation or rising prices within the economy. If one’s bank account returns only 3.5% pre-tax, but the level of prices is rising at 10%, one doesn’t have to be a mathematical genius to figure out that in the long run one’s standard of living will suffer. You will hardly be able to create any wealth, because whatever returns you earn does not even help you keep pace with the rising prices in the economy, let alone give you a surplus that can earn you further returns.

If you are already wealthy then FDs might be a good wealth preservation instrument, but please don’t use them to create wealth for yourself.

Don’t sit idle, invest actively

Putting your money into a savings account of an FD is almost akin to sitting idle. India is going through an inflection, which is likely to last for a few decades, where the equity capital markets will be the best avenue for long-term investment and a good way to build an alternate and legitimate source of wealth. If you believe in India’s economic growth potential, then move at least some of your money from your bank account into a higher yielding instrument to give yourself a fair chance to create long-term wealth.