Planning your long-term financial goals? MFs or Ulips may be the way to go, as these schemes offer better returns than bank FDs
CAN you find anyone who has become wealthy by leaving his or her money in the bank or a fixed deposit (FD)? If you want to create wealth, you must move away from this mentality 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 miss the bigger point. The reality is that bulk of 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 it's an even scarier thought that most of us prefer to leave our money in a bank, rather than in instruments that are higher yielding, be it 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 vis-a-vis choosing to invest through instruments like mutual funds and Ulips that offer a reasonable prospect of better long-term returns.
MUTUAL FUNDS VS ULIPS
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 it's 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 will have one of the following goals that require a substantial amount of money in the future: funding 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 in 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 eighth wonder of the world because it allows for 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 & FIXED DEPOSITS
Let's make ourselves clear. Savings accounts and FDs have a purpose and we cannot over generalise 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 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 as 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.
