How you can be RICH without much risk

The concept of savings and investments has noticeably changed over the years. The time has come when every individual and prospective investor should realise the significance of these two words and learn to differentiate between them.

Evolution of lifestyle and our savings

In order to understand the significance of investments today, it is essential to look into our lives and analyse our needs for the present and the future. The situation has changed from the period of our parents and grandparents when they considered their savings would suffice through their lifetime.

Although the core ideas behind savings have remained much the same -- such as emergency needs and social needs -- there has been the introduction of aspiration needs as well. The fact that aspirations have become realisable has furthered this need.

• This is evident from the fact that the average age for house owners was 42 years in late nineties as compared to about 34 years now.
• The aspirations of flying abroad for holidays, maintaining a certain lifestyle, quality education for children and various personal goals have come within the reach of the people.
• The consumer revolution and the easy availability of loans for almost every purpose have increased the household liabilities many fold. In fact, the average retail liabilities of the country have jumped to above Rs 2 lakh crore (Rs 2 trillion).

The result of this change has been an increased need for money, which at times becomes difficult to be met by simply saving. The savings philosophy too seems to have changed. Earlier savings preceded expenditure while it is now vice-versa.

Simple forms of savings in the form of deposits or administered savings are no longer sufficient to meet the ever-increasing requirements of the household. Thus the time has come to save intelligently through the various avenues of investment.

It is essential to note that it is no longer sufficient to 'save' -- the need of the day is to 'invest'.

India's domestic savings as a percentage of our GDP stand at 28 per cent -- one of the highest in the world. A significant proportion of this savings is in the forms of fixed deposits that fetch an interest below the rate of inflation and are further reduced after taxes.

This reflects that we are losing a significant proportion of our savings by allowing inflation to eat into it.

The time has come for us to look at investment avenues that can beat inflation and help our money to grow further in order to meet our future requirements.

Investments in various forms will enable us to meet inflation and protect our purchasing power along with aiding us to generate a sustained income post retirement.

Not investing in equity could mean a higher risk

Investments can be regarded as secondary source of income where we allow our money to grow for the future. One of the available investment avenues is equity-related investment, where currently only 2-3% of household savings are invested.

• One of the reasons why there is an under-ownership of Indian households into equity asset class is the availability of assured return investment options. Now with the structural decline in interest rates, the returns are likely to be largely commensurate with the underlying risk. The high return-low risk syndrome will have little place in the fast changing investment landscape in India.
• Indian investors have been traditionally risk-averse. They need to appreciate that buying into an equity share is buying a part ownership of the company. As there is the case with any business, the gestation period would be longer, say 2-3 years or so. There could be volatility in the intermediate period; however, the returns are worth the wait and the intermittent risk.
• By not investing in equity investors feel that they are avoiding risk but they may be taking a greater risk since their investments will be unable to cope with inflation and tax.

The figure below clearly highlights that on 20 years CAGR equity as an avenue of investment has outperformed inflation and other significant investment avenues. Ask yourself, "Have your savings grown post-tax, post-inflation?"

It has been statistically proven in many markets, including ours, that over time, equity outperforms most asset classes. It helps to think of risk as an opportunity. "Nothing ventured, nothing gained" applies just as much to the stock market as to other aspects of life.

The markets have become very volatile and are dominated by wholesale investors. Such wholesale investors do extensive research on all the companies that they invest in. The markets today discount the forward performance in advance and the stock prices merely adjust depending upon the quarterly performance.It, therefore, becomes very difficult for a lay investor to track corporate performance on a continuous basis. It is here that the mutual funds offer adequate diversifications.

Mutual funds: A proven investment vehicle

Mutual funds allow investors to reap the benefits of a diversified, well researched and an actively managed portfolio, without having to worry about liquidity.

In several developed countries, the mutual fund industry is a bigger financial intermediary than even the commercial banks. For example, in the United States, the assets under management are larger than the aggregate bank deposits. The relative size just goes to prove the role of mutual funds in wealth creation for investors at large.

In India too we anticipate a higher allocation of household financial savings in securities market, through the professional managers.

The power of active funds management

Consider the performance of mutual funds over the last 10 years, as on August 11, 2005. The average returns of the top 5 diversified equity mutual fund schemes is 24.69% CAGR, whereas the BSE Sensex has grown by only 8.66% CAGR. It implies that Rs 100,000 invested in mutual funds 10 years back would have grown to Rs 9.08 lakh, whereas the same amount invested in BSE Sensex companies would have grown to only Rs 2.29 lakh. This is the power of active management of your assets.

Systematic Investment Plan: An effective solution

The secret of wealth creation through investments lies in disciplined investments and not in being lucky. The performance of equities is affected by the volatility in the market.

Market sentiments act as a driver for equity investments pegging them down or pulling them up at times. The mutual fund industry provides a solution to all these aspects in the form of Systematic Investment Plan (SIP).

The idea of Systematic Investment Plan consists of providing fixed amounts of investments at regular intervals and in the same scheme. In terms of pattern, it is comparable to paying monthly installments in the form of EMIs (equated monthly instalments) for asset-finance. SIP can be used as an ideal investment avenue to meet the increasing load of liability that has entered the life of Indian consumers today.

• SIPs help make the volatility in the market work in favour of the investor.
• If the same amount is invested at regular intervals of time, the purchase cost will be averaged out.
• When the NAV of the scheme is increasing, the average cost of purchase of units will be less in the case of an SIP. In the very opposite situation where the NAV is falling, investments in an SIP will allow the investor to buy more units in the scheme.
• One of the most significant benefits of SIPs is the advantage of compounding about which Benjamin Franklin had once said "compound interest is the eighth wonder of the world."
• Finally another advantage of SIP is the available convenience with which an investor can invest in the available schemes. The amount of savings to be invested monthly can be decided at the convenience of the investor.

Early investing has its advantages. Consider the following example:

It is evident in the present economic circumstances that inflation is a reality and has to be tackled. Mutual funds, and especially Systematic Investment Plans, may be the ideal mix for an investor to overcome inflationary consequences and further create wealth.