Where do I invest my savings? [Part 1]

Indians, traditionally, are good savers. As per the latest Economic Survey of India, household savings was 22.6% in 2009-10 and has now been stable for past three years. This means Indians, on an average, saves roughly ¼ of their earnings. 

However, the good part ends here. Most of these savings (roughly 50%) goes into fixed deposits and savings account. There is nothing wrong in parking your funds in fixed deposits however; fixed deposits are not an ideal instrument for long term savings. They are capital-protection investment and not wealth creation investment avenues. They provide minuscule returns after adjusting for inflation. And in times like today when inflation is increasing, they offer negative returns i.e. a case where inflation is more than the interest rate. Add to above, the interest earned on fixed deposit is taxable. Hence your actual income after taking into account the inflation and taxes is negligible. On the positive side, it is risk-free and provides liquidity, capital protection and predictability of cash flows.

For long term investment one should look beyond fixed deposits. There are various wealth creation alternatives available which have an ability to provide enhance returns with proportionate increase in risk.  In this post we shall discuss the various alternatives available for an individual investor.  Note that the alternatives discussed here are keeping in mind what should form part of an average individual investor’s portfolio. For high net worth individuals, there may be more exotic alternatives available which are outside the purview of this post.

1. Fixed deposit: The pros and cons of fixed deposits are already discussed above. However, it is better to have funds in fixed deposits rather than in savings account.
2. Provident Fund: It can be in the form of public provident fund (PPF) where an individual can invest up to Rs. 70,000 per annum or Employees Provident Fund (EPF) where employee as well as employer makes periodical contribution. They get preferential treatment in taxation and are good source for retirement savings. It should form part of any individual’s portfolio. The investment earns a good tax-free interest. Generally the rate of interest on EPF is more than PPF, however both have different tenures. 
3. National Savings Certificate (NSC): It provides return of 8% and is virtually risk free. The tenure is for six years and contribution as well as interest earned is tax-free within the limits of Sec 80C of the Income-tax Act.
4. Kisan Vikas Patra (KVP): Similar to NSC, it is risk-free long term investment plan. It provides 8.25% return over an investment horizon of eight years and seven months.  Unlike NSC, premature withdrawals are permitted after two years and six months.  However there is no preferential tax treatment and interest is taxable.
5.  Corporate Debts and Company Fixed Deposits: These are debentures and fixed deposits issued by companies. They are available for the tenure of 1 year to 10 years. Debentures or deposits of good corporate are low risk investments and one can earn higher interest as compare to fixed deposit. Now it is mandatory to list the debenture on stock exchange and is regularly traded albeit with small volumes. Hence liquidity may be a problem for substantial investment.
6. Pension Scheme: Pension plans are offered by mutual funds & insurance companies. However, recently introduced New Pension Scheme beats these plans. As per draft Direct Tax Code Bill, tax treatment for pension plan will be same as that for provident fund .  The investment amount will be deducted from total income, subject to overall limit and will also be exempt from tax at the time of withdrawal. They are good long term investment vehicle wherein your investment is locked till the age of 60 years. It invests part of the money in index funds and it can be actively or passively managed depending on the option you choose.

(to be continued…)

Comments deeply appreciated.