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Are you saving or investing?

There are two kinds of people, really – those who have extra money left over at the end of the month, and those who don’t.

I’m assuming you’re one of the former, otherwise you shouldn’t even be here. So what do you do with what’s left over?

1) Do you put it in a bank account, and spend it whenever you have a big purchase like an LCD TV, an iPod, a camera?
2) Do you make a fixed deposit every month (or once you have a large sum)?
3) Do you buy mutual funds, shares, or other investments?

1) is a Saving. 3) is an Investment. 2) is “saving” according to me (but others will think of it as an investment) There’s a difference.

An Investment is where you can grow your money significantly above inflation, after tax is applied. Remember that quoted inflation is around 5% but for real terms, it’s around 6.5% a year. That means your money needs to grow ABOVE That for any real returns. An investment MUST carry some amount of risk; assured returns are usually negative post-tax and post-inflation.

Savings are everything else. Money in the bank, in a fixed deposit, hidden in your pillow etc. Even bonds and debt mutual funds, in my opinion, are “savings” – they hardly return more than inflation post tax.

You might think “No! A fixed deposit can grow at 8% a year!” Reduce tax on that amount at 30%, you’ll get 5.6% left over. That’s still less than inflation of 6.5%.

Shares and equity/balanced mutual fund units are investments. They carry a large amount of risk, but have the potential to grow much more than inflation. Gold and other commodities are investments too, and so is real estate, paintings (art) etc.

Within investments you have two types: cash-flow and value-appreciation. Cash-flow means you get money ever so often; royalties from books, dividends, rent (from real estate) etc. Cash-flow income is usually called “passive income”; meaning you don’t have to work for it.

Value appreciation is growth in the intrinsic value of what you buy. (Note: Cars, iPods etc. are not investments. They lose value from the minute you buy them!)

Most people usually buy for value appreciation, since there are limited cash-flow options available. In India for instance, both dividends and rents are around 3% post-tax, and that’s no fun. But there are a few companies that consistently give 10% dividends, and places where you can get upto 7% as rents. You just have to look harder.

Investments are your future. Savings are your present. Straddle the two – keep around 40-60% of your money in investments and the rest in savings. You need your savings to build up your purchases and pay extraordinary bills (like a pregnancy or hospitalisation), but don’t forego your investments either.

If you want to ensure a stable future, invest more. Key check:
1) It should “appreciate” in value (either through cash flow of value appreciation)
2) It should have an element of risk.
3) It should have the ability to grow more than inflation.

  • Anonymous says:

    >Nice Article!

  • Venkatraman says:

    >First i want to thank u 4 giving a very good articles. If possible, u can
    try to have ur own podcast [Just a suggestion].

    “In India for instance, both dividends and rents are around 3% post-tax”

    But for dividend, there is no tax right [i read somewhere in ur articles only 🙂 ]. Generally what is tax (%) for rent.

  • Deepak Shenoy says:

    >Venkat: Thanks! As for the tax bits: Dividends are tax free in the hand of the investor. Rents are added to your yearly income, though a deduction of 30% of rent is allowed. At the highest bracket you pay around 21% of the rent as tax.

    The “yield”, meaning the total post-tax money on the amount invested, is typically 3%. Meaning if you buy a house for 50 Lakhs, you will get around 1.5 lakhs in hand as rental income post tax. And if you invest the same amount in shares, the shares will typically give you Rs. 1.5 lakhs in dividend each year.

  • dhiraj says:

    >i have a question here ..
    if a person was to make maybe around 50 lakhs from a land deal which does not belong to him ..
    how much tax would he have to pay .. by asking others i did find out it would be 33% ..
    but i did also hear this that if the person were to invest the whole pricipal amount in FIXED DEPOSIT , he would not have to pay the 33% tax ..
    did debate this with a lot of people but want a clear idea which is the right one ..

  • Deepak Shenoy says:

    >dhiraj, for 50 lakhs made on a land deal that one does not own, the tax will be 33.66%. IF you don’t own the land, capital gains does not apply, it comes as “income from business or profession” or “income from other sources” (either one depending on what you choose to do). You can’t invest such money anywhere to save tax. You can only claim expenses against it – for instance, your fuel bills involved in making that deal, any other expenses etc. Talk to a good auditor or accountant who can help you figure out how to legally reduce your tax liability.

  • Anonymous says:

    >Hi Deepak !
    I am new to ur blog.
    I appreciate ur writing style. It instantly engages a reader and keeps engaged till the last word.
    I am very much impressed.
    I will be in constant touch with ur articles henceforth.


  • tintin says:

    >hi ..
    its nice article buddy.. earlier i was planin to buy a bike frm my savin but now i thnk i can do with my old one…… its rite time to invest as i hv jst startd earnin… i was jst goin thrgh latest edition of reders digest today i.e. march 2007 issue… it has got an intresting information about investment pattern and abt various investment options… jst wanna say thanks…. will be looking for mor from you…..


  • ashwin haldipur says:

    I’m a regular reader of your blog. Talking of an investment which we calculate above inflation, after tax is applied, would you agree that anything that gives above 10% is a good investment?
    Let’s look at MFs, the returns range from 83% (DSP ML Technology) to sometimes 10% (quite a few). What tips can you give new investors to look for when buying MFs? NAV or returns over 1,3 or 5 years, Brand or Fund Manager’s credentials?
    Thank you.

  • Deepak Shenoy says:

    >Ashwin: Buying MFs wise, I’d say go with the fund’s objective (diversified, sector or small/mid/large cap) and then with the performance. I would say anything that beats the indices is good performance = typical long term nifty perofmrnace is about 12% annual.

  • Anonymous says:

    >THANKS for good advice in a simple manner!its easier to understand your language than the fund advisors!
    give me your perspective of NRI funds investment in mutual funds!is it really worth the trouble considering the taxation sword hanging on mutual funs vis a vis the NRE deposit tax haven!

  • Anonymous says:

    >can you please explain the method in the madness of being advised funds which declare high dividends and then they dont perform for some years! is it like dividend stripping in shares?

  • Anonymous says:

    >a fund like icici prudential technology fund has invested in pharma shares also…is this justified by the fund manager or are they desparate?

  • Deepak Shenoy says:

    >Thanks anonymous(es)! I have no idea how much NRIs pay as tax when they invest in mutual funds so I’ll have to pass there, but for equity mutual funds tax may be lesser (than for debt funds)

    Funds with the lure of high dividends aren’t worth it because that’s simply your money coming back to you!

    ICICI Tech fund investing in pharma: If they are you should check the offer document to see if that is fair game. If it is, they’re fine – just a sorry name for a fund. but they’re all like that – check out SBI Magnum “contra” fund which is supposed to have “unrecognised stocks” as a contra investment, yet the names of the companies they own are mostly sensex scrips!