Are You SAVING or INVESTING?

Most of the time we misconstrue savings with investments. But let us tell you that there is indeed a difference between the two.

Investment means let your money start working for you. Whereas putting aside money under the mattress, or in a vault, bank locker or savings bank account after meeting your expenses and liabilities can be called as savings, which does not mean that money works for you.

In times where the inflation bug is eating into our earnings, we need to move a step forward and invest. More importantly, invest wisely!

Let's delve a little deeper and understand the difference between the two...which can help us march forward in our journey of wealth creation.

What is Savings ?

Savings refers to preservation of wealth for future use. It is an act of putting aside money after defraying expenses and liabilities (...therefore the unspent income results in savings). To put it simply:

Savings = Income - All expenses including obligations towards borrowed money

How to Increase Savings

1. Make a a budget ...Ascertain your income and necessary expenses. frame the budget in a way that allows to save more. 
2. Control the expenses ...try to avoid those expenses which aren't necessary.
3. Refrain from impulsive buying ... Before going for shopping make a list so that we can be within our control and do not indulge into unnecessary purchases. 
4. Start saving at an early age ..the sooner the better. The early we start planning the better and easy it would be. Remember, we can always postpone our decision to buy a favourite gadget, but should save for a rainy day.)
5. Don’t over-borrow / credit ..Now a days banks/finance company’s gives consumer durable loan just by pan card/ address proof and cancelled cheque even car loan and personal loans are also very easily available. However it does notmean that we should take watever is available. Similarly we may own and use a credit card, use it thoughtfully knowing our means - Remember: excessive credit can lead to a debt trap!
6. It may be small start but save regularly ....Remember, single drops poured regularly can fill the buckets if …so we must remember that every bit of savings can help you attain financial freedom.

Finally: 

As explained above how should we shave but then the next questions comes it just saving the money is enough? By just saving can we achieve our life's goals? - Which could be: buying our dream home, dream car, sending kids abroad for higher education or their marriage, money for retirement or amongst a host of other ones. 

Lets think about it. 

We know, over the years, the value of money diminishes due to inflation. So the money we have saved - kept aside in your vault, bank locker, savings account, or under the mattress - may lose value as the inflation bug eats into your savings if it is not allowed to grow at a decent pace? Therefore, in order for it to grow, we need to put our 'money saved' to money invested as in productive use - and make money work for us! 

And what should we do to make money work for you? 

Well, the answer lies in INVESTING!

What is Investing?

Investing is an act of laying out our 'money saved' for productive use with an expectation of earning return more than inflation to preserve purchasing power of money We can call it is a process of making our 'money saved' to work for us (instead of simply stacking in our vault / bank locker or under the mattress)

How does investing benefits us ?

1. It will grow our savings
2. As it is put on productive use so it helps our money work for us
3. It helps in countering inflation and maintaining purchasing power of money …As said earlier the money tends to lose its value over time due to inflation - which eats into our hard earned savings - we can counter the inflation bug by investing and maintain the purchasing power of money for our future..
4. We can achieve our financial goals in life ...like buying a dream home, a car, taking care of children's education needs, their marriage and own retirement amongst a host of others..
5. Helps wealth creation…this way we can create wealth and leve it for our next generation to remember us…
6. Provides a sense of financial security…as we all call “baap bada na bhaiya sabse bada rupiyaa”….if we have money we can feel secure and enjoy the life..

What is the Right Approach to Investing?

1. Objectives should be clear ... First of all we should be clear that why we are investing with what objective in mind.. whether it is long term or short term..             as different investment avenues are meant to cater to respective investment objectives. So enough care should be taken while investing money. Ideally each of our investments should match our investment objectives.. 
2. Understanding our own risk tolerance ...if volatility makes us nervous then risky investments such as stocks and equity mutual funds may not be the ones for us and we have to find other stable and safer options in fixed income instruments instead, such as fixed deposits, PPF, etc…
3. Know the risk involved while investing ...as we all know that, every asset class – i.e. equity, gold, bonds and real estate - has risk associated with it and therefore it is necessary to know about the same before investing we put our hard earned money in them.. 
4. Consider our age and earning horizon ...this will help to have the right investment instruments appropriate for your age)
5. Clarity about the time period for the investments ...As we all know the longer the investment it will give more of the returns…and also can take higher the risk..by investing in risky classes but before that we should be clear that when we need this moany so that it can be invested accordingly..
6. Do sufficient research ...It is important that we should not get carried away by exuberance and / or what other like friends and family say. Instead, we should undertake solid fundamental research on respective investments, and please do not get caught up in hype....understand how the product works)
7. Assess cost of investing (...Everything has its own cost…so we should be aware what he hapveto pay for that particular investments.. it is vital to keep an eye on terms and conditions associated with the investment avenue. Very often many indulge in trading in the stock market to make a quick buck without really understanding the associated costs they are paying for regular trading or churning..
8. We should focus to invest which earn more than inflation (...Investments should be able to beat inflation if we really want them to grow and match the future requirements.. it will also help to achieve your financial goals smartly and efficiently)
9. Know the tax implication ...tax is a very important part of investments as it can eat a ajor part of earning so we should know which are tax efficient options and how best we can use it in our favour. Or else we may end up paying higher tax on returns..
10. Sooner the better...we should start investing by the time we start earning…as there are benefits of doing so. we can understand it well by taking a look at the following table and chart)
    
    

The Sooner the better..

Let us take an example of 3 friends – Ram, Shyam and Balram - All 3 had good jobs and wanted to retire at the age of 60. Ram being the smarter of the lot, started planning for his retirement at the very initial stage, at 25, and invested Rs. 10,000 per month. Shyam realised the importance of planning for retirement once he was 30, while Balram could feel the guilt of being left out only when he was 35. See what they accumulated when they were on the verge of their retirement. 

Particulars	Ram	Shyam	Balram
Present age (years)	25	30	35
Retirement age (years)	60	60	60
Investment tenure (years)	35	30	25
Monthly investment (Rs.)	10,000	10,000	10,000
Total Investment Amount (Rs)	42 Lakhs	36 Lakhs	30 Lakhs
Returns per annum	12%	12%	12%
Sum accumulated (Rs)	6.43 Cr	3.49 Cr	1.88 Cr

(Return per annum mentioned above is for illustration purpose only)

Not only this, they also noticed a wide deviation in the proportion of growth they saw on their invested corpus. While Ram's money grew around 15.3 times, Shyam's money grew 9.69 times and Balram saw a growth of just 6.26 times

Its important to remember while investing..

Finally, we should always keep in mind following points while investing..

To Save

1. SAVE before you spend.. ...: It is always important to control our expenses and save for a rainy day.. 
2. It is never too early to save ...we should start saving from the day we start earing..its never too early..in fact, savings can help you feel financially secure and you can slee in night without worry for the next day..
3. Small amount also matter but do it regularly…AS said above small drops can also fill the bucket if they are pouring regularly…so don’t postpone investments as you feel its too small to save.. 

While Investing

1. Don’t be in hurry while investing (...undertake thoughtful research by doing a detailed study)
2. Its not a joke ..Investing is a serious activity (...for non-finance background people it can be a boring activity but its serious activity and should be given proper weightage…
3. Don’t speculate ..Although trading  can be a thrilling experience, but it can be killing as well if the tide turns against our expectations. So it is best not to fall for excitement and exuberance)
4. Invest emergency funds in safer avenues (...Emergency funds should be kept in saving accounts or liquid funds not for long term investments like equity or equity mutual funds.. remember, they are put aside as part of your savings to meet your requirements on a rainy day
5. Invest own money not from borrowed funds ...Investment should be made out of own funds except in the case of investing in real estate or your own business; but again, while investing therein don't go beyond your means..
6. Know where we are putting money...understand the basics where we invest how it works and undertake research; recognise the risk-reward relationship the product offers..
7. Diversify ...Never keep all the eggs in one basket ..diversification can help to reduce our risk to your overall portfolio if we diversify wisely..

Some Important Ratios to Track Your Personal Finance

Total investment to Income Ratio =	Current Value of Total Investments
	Total Annual Income

This ratio helps you understand the current value of investments done as a ratio of current income. 

At a younger age this ratio tends to be lower. However with time one needs to accumulate enough savings and invest to fulfil various financial goals in life. 

Savings to Income Ratio =	Total Annual Savings
	Total Annual Income

This ratio simply tells you what part of your income you are saving annually. Higher the ratio, the better it is, as it facilitates you to invest and lets your money work for you. 

Debt to Income Ratio =	Total Debt
	Total Annual Income

This ratio would help you evaluate the proportion of total debt as against the total annual income you earn. 

Lower the ratio, the better it is. 

Following these ratios, can help us to keep a track of your finances.

Can equity be a fearless investment option?

The greatest enemy of any investment is inflation. In the developing economy like us we have to live with high inflation.  When we talk about inflation its not just CPI or WPI numbers as published by the government every month but there are various other services like what we pay to doctors, school fees, barber etc. which are not covered in the index but has a very significant impact on our investments and savings. It means that the inflation-adjusted interest rates that we earn from fixed-income investments like deposits etc are actually negative when compared to the real inflation rate that consumers face.

  

This inflation is due to structural and demographic reasons and could not be solved in a very short period. Hence it could be years before we get positive real returns from fixed income securities (FDs, bonds etc). In this scenario equity is one of the assets that has the potential to beat inflation to earn real returns. It is for this reason that we should have a significant exposure to investments in equity in any of the investment portfolio.

However when we talk about equity investments any normal investor’s first reaction is that it is risky. The risk of losing money is more dominant than earning and keeps most of the investors away. Further short term ups and downs and coverage by print and electronic media gives the impression that the investments will always be moving ups and downs without giving any stable returns. As the stock market goes up brings lot of happiness with the investors on the other moment as it falls they get devastated.

However when we talk about equity, this volatility is an illusion. How can this be? How can returns from a type of investment that is volatile be high and safe. The answer is to understand that the same thing can look very different at different scales.

Let’s take an example of a man playing with a yoyo going upstairs. Everyone watches the yoyo which is moving up and down but does not see that the man carrying the yoyo is actually going up. Similarly in reality, the returns from equity are not only high but they are quite safe too.

Let’s take another example. What is the coast line of India? The official answer is 7,517 km. But will everyone have the same experience awhile covering the entire coast line. from Gujarat to West Bengal. If an ant walked the entire distance, would it come up with the same answer as a man will walk through? And how about an aeroplane covering the same distance?.

In each of these cases the answer would be very different. The ant may come up with an answer thousand of km higher because it would follow each nook and corner of the coast at the scale of millimeters. A human being would follow it on a scale of feet and come up with a lower answer. An aeroplane would follow it only on the scale of many kilometres and would come up with a far lower answer.

Stock market volatility is a bit like this. If we track the markets everyday, we will see many ups and downs. If tracking it once a month, there will be fewer ups and downs. On the scale of an year, the ups and downs would be even fewer and if we look at the markets only once every two or three years, there would hardly be any volatility. Now, imagine the scenario once in a decade or for even longer periods.

Let’s see the two charts below. One is that of the BSE Sensex' daily movements from 1990 to 2015. The other is the same time period, but marked only once in five years!

The first graph can put the most intelligent and smart  investors also in a difficult and worrisome situation. However, the second graph is very smooth and shows practically no volatility.

For example is we had invested in stock market in 1990 and then checked the investments only once in five years, then sometimes it might have risen more and sometimes less but would have given positive returns most probably. Over longer time such as a decade or more, the movement of Sensex evens out, thereby reducing volatility in reality.

Like we cannot cover a 5000 km distance by a cycle but an aeroplane whatever risk it may look like similarly to cover our bigger financial goals over a longer period of time, equity is the best option.

The message for the investors is: that investing in stocks can lead to frequent losses only if we are a short-term trader. Over sufficiently long periods of time, it is  like aeroplane flying over the coastline. The little twists and turns that vex the ant are not your concern. But do we need to invest in equities directly? Its not required if we are not experts its always better to taken the services of experts. So to invest in equity sensibly and make money out of it, there's no need to actually get into stocks and shares ourselves--equity mutual funds will do the job for us.

How to become a Smart Investor

Robert Kiyosaki, author of Rich Dad, Poor Dad – The #1 best-selling personal finance book of all time says “Investing is not a get-rich-quick drama.  Investing is a plan, often a dull and almost mechanical process of getting rich.”

He further adds that “Investing is less risky than being an employee. Skilled investors are in control of their investments; employees are under the control of their employers.”

To start with investments we have to first pay of costly loans like credit card dues, personal loans etc and reduce the expenses so as to have some money in hand. From there we start with the investment process. Every individual have different objective and risk taking capacity; for example if our goal is security and comfort rather than riches, we should keep our investment in fixed income securities etc.

Let’s discuss the simple tools for making smart investments and how to achieve a secure financial base. These rules are to have a basic understanding and to be an average investor.

Basic Rules for Investing

Let’s start with the basic rules. If we follow these rules during our journey towards financial security and freedom, they’ll keep us on the straight and narrow path toward comfort and security.

1: Know what kind of income from the investments

Returns from investments are in terms of dividend, interest, capital gains etc. Before making any investment we should know that what type of income we want to receive and accordingly the investment decisions should be made. Are you dealing with ordinary earned income like from the salary or returns from the portfolio, i.e. Rent from property, dividend or interest as a passive income?

2: Find the ways to earn passive income

By investing in those assets by which the money can start working for us is a smart investment decision. For example, buying a property and put on rent or investing or in the fixed income securities or investing the profits (rent income or interest) in securities to get a regular income for a positive cash flow. We can take the help of a financial advisor can help us to handle investments in ways that maximize tax efficiency.

3: Buy assets with positive returns.

Financial assets like shares and bonds can lose value and become liabilities. While no investment is risk-free, the educated investor will strive to buy those type of financial assets that provide a good return on investment.

4: Take smart decisions use the opportunities

A smart investor buys undervalued securities in a bear market or lucrative real estate in foreclosure. A bad investor enters when the market is on its peak and locks in losses on a stock by panicking in a market slump. An smart and educated investor takes decisions based on fundamentals and keeps his emotions away from investment decisions.

5: Be prepared for eventualities. No one can predict the future.

As a smart investors we should know market and economy’s future direction is based on various reasons and we cannot control the these factors or the market, let alone the global economy. Therefore having good understanding of market and taking decisions based on the overall investments objectives (long terms or short terms etc) is the best way to counter it. Accordingly a financially intelligent investors thinks confidently and creates opportunities out of the problems.

6: Have defined financial goals

If we have defined place to travel we can find out the best way to reach there. Similarly if the financial goals are defined and clear it would be much easier and achieve them. An investor can accordingly use the right tools (fixed income securities for short term and equities for long term etc ) to achieve them.

7. Understand risk and reward relationship.

Generally Risk and Return are directly proportional and moves in same directions, means higher the risk may give higher returns. There is risk in every investment, but risk is a relative term. An investor who understands financial statements of company and can evaluate a business system, or take the pulse of the stock market has a greater chance of buying an good stock than a dud one. Since risk is often directly proportional to reward, anyone who hopes to become wealthy must be able to invest more aggressively than someone who’s content to be secure. The more financially educated you are, the less risk you’re taking.

Arbitrage Mutual Funds: Another Smart way of earning high tax free returns in short duration

If I ask any one of us generally about safe and tax efficient short-term investment avenue to park surplus money other than the fixed deposit, most of us will answer “Liquid Funds are the best for a short-term investment”.  Many of us believe that Liquid Funds are the best alternative to Fixed Deposit which might be true also for some case. But is it really true always? Are Liquid Funds the best tax efficient option to park short term funds (three months and more).If your answer is ‘Yes’ then you must read below to understand why Liquid funds are not tax efficient short-term investment avenue.

The convenience and better absolute returns from the Liquid Fund for very short-term, even for overnight investing is very significant. This makes it attractive even though there is no tax advantage as for all debt based mutual funds (liquid fund is a debt based mutual fund) we have to pay short term capital gain tax based on the slab rate if it is redeemed before three years. So if a person is at highest tax slab, he has to pay almost 1/3^rd of the income as capital gain tax, in a way tax liability is similar to the FDs.

So what could be another option to get better returns without risking the capital?

Answer could be the Arbitrage Funds. Arbitrage Fund leverages the price differential in the cash and derivatives market to generate returns. The returns are directly dependent on the volatility of the asset class i.e. Equity Market. However, It would still be market neutral i.e. No specific equity risk as they would be buying and selling the stocks simultaneously in cash & future market.

These funds are hybrid in nature as they have the provision of investing a small part of the portfolio in debt markets.

Arbitrage Mutual Funds are mainly for low risk-taking investors. In a situation of high and persistent fluctuation, Arbitrage Funds offer investors a safe opportunity to park their hard-earned money. These funds take advantage of the Equity market inefficiencies and secure profits for the. These funds invest primarily in equities; hence their tax treatment is same as equity mutual funds.

What is Arbitrage and how they earn?

As the name suggests, Arbitrage means encashing the inefficiencies of two markets. In equity market these are the price differences between cash segment stock price and future segment (F&O). These funds encash the opportunity (which we call as arbitrage opportunity) of the price difference in these market. The difference in these market exists due to insufficient flow of information between two market prices and time value of money however it is temporary in nature. Sometimes due to huge buying/selling in the particular segment of stock or huge volatility in market generates arbitrage opportunity.

There are various reasons due to which these price differential exists like stock specific news i.e. quarterly or annual results, corporate governance issue, bulk buying or panic selling etc. these events generates arbitrage opportunity because of the relative price difference in cash and future market. Generally Arbitrage Fund uses hedging strategy; they buy stock from cash market and sell those stocks in the future market to lock price difference between two segments of the market.

Arbitrage strategies followed are different for different asset management companies; some may adopt strategies like Index/Stock cash – Index/Stock future, ADR/GDR, Buy-Back Arbitrage, Hedging and Alpha strategies, cash-future arbitrage strategies or corporate action or event driven strategies. When fund manager feels market having very less volatility or arbitrage opportunity, he may invest a sizeable amount in debt or money market securities to generate stable returns.

So how it works?

Assume that price of XYZ stock is quoting at Rs. 100 in the cash segment, whereas the price in the Future market is Rs. 101. At this point of time fund manager, can make the profit by purchasing stock in cash segment and selling an equal number of shares in the future market. So after doing this translation fund manager locks in Rs 1 profit per share on the day of settlement without getting worried about daily price movement or market directions.

Investment done is the cost paid for cash market buy and margin value of the future contract. Profit will be booked on the day when stock price of both the market match or on the last day of settlement and the fund manager will reverse his position in stock, he will sell stock holding in cash segment which was purchased and will buy contract in the future segment.

Mostly returns generated by schemes are based on the efficiency of fund manager’s opportunity spotting skill and trade execution skill of his team. Cash price and Future contract price generally converges at the end of the month, so he will make very low risk return of around 12% [(101-100)*12/100].

Who could be the investors?

Arbitrage mutual funds are alternate to liquid/short term funds and mostly suitable for parking money for the period of 1 month and above. These funds are basically locking available spread, so return are purely dependent on arbitrage opportunity available at particular point of time. Arbitrage Funds have exit loads generally in the range of 7 days to 3 months, it should be kept in mind before investing. Another important aspect is Arbitrage Funds are mildly fluctuating in the short run, sometimes even 1-month scheme return do not look attractive compared to Liquid Fund, ultra or short-term income fund. Monthly returns of Arbitrage Funds are always volatile due to monthly expiry at different spreads.

These funds are for parking short term cash and are not long-term wealth creators. Arbitrage Fund do not invest like other equity-oriented schemes, they do not take any directional bet on Equity market, they just lock the spread available between two prices at same point of time, hence Arbitrage Funds are not for the long-term wealth creation. So an investor should use it as a liquid investment and do not make it a major part of the portfolio.

Arbitrage Funds are mostly suitable for those investors who are in 20% or 30% tax bracket. If an investors investment horizon is less than 1 year, go with the Dividend option and investor who wish to stay invested for more than 1 year and less than 3 years should go with Growth option. An investor who is willing to invest for more than 3 years can also look for growth plan of the Liquid Fund, FMP, Ultra short-term or short-term mutual fund also.

How it benefits the investors?

For those investors who are in 10% tax category, Liquid Fund returns are in their favour compare to Arbitrage Fund returns and that is because of tax treatment on a capital gain (Short Term Capital Gain tax is as per slab rate). But for investors, who are already paying 20% or 30% income tax, due to the adverse tax treatment of debt mutual fund, their actual post tax earning will be very less if invested in Liquid Funds. Hence any return you earn after holding it for 12 months is tax free, and in case you hold it for less than 12 months and make any profits, the taxation is 15% (short term capital gains tax) however the dividend received anytime is tax free.

Investment Horizon	Debt Mutual Funds		Arbitrage Mutual Funds
	Dividend Distribution Tax	Capital Gain Tax	Dividend Distribution Tax	Capital Gain Tax
Upto 1 Year	Individual 28.84% Company 34.61%	Income Tax Slab	NIL	15%
Between 1 and 3 Years	Individual 28.84% Company 34.61%	Income Tax Slab	NIL	NIL
After 3 Years	Individual 28.84% Company 34.61%	20% less indexation	NIL	NIL

For example an investor who is paying 30% income tax (ignoring surcharges for the sake of simplicity) invests in Liquid Fund for the period of 6-month to park surplus money. After six months of investment, his post-tax return would be much lower compared to return generated by Arbitrage Fund (here we have assumed 8% annualised return in liquid funds and 7.5% in Arbitrage funds based on current returns). He will be earning merely 2.8% post-tax return from the Liquid Fund scheme against 3.8% post-tax return from Arbitrage Fund. If he has invested Rs. 10 lakhs for six months, just by keeping the funds in arbitrage funds instead of liquid funds he would be earning Rs. 9500/- extra which is 34% more as compared to liquid funds.

Particulars	Liquid Fund	Arbitrage Fund
Annualised Return	8.0%	7.5%
Tax Slab	30.0%	30.0%
6 Months Return	4.0%	3.8%
Tax on Returns	1.2%	-
Net Return	2.8%	3.8%
Amount invested for 6 Months (Rs.)	10,00,000.00	10,00,000.00
Net Income (Rs.)	28,000.00	37,500.00
Difference in Income (Rs.)		9,500.00
% Difference		33.9%
Tax Slab is taken the highest bracket and ignore the surcharge for the sake of simplicity

It is clear that by selecting the correct investment vehicle considering time frame and individual’s tax bracket, one can actually get much higher returns by doing his homework properly and understanding the tax treatment of different class of mutual fund schemes.