Inflation allows you to live in a more expensive neigbourhood without moving. – Anon
In good old days, people used to save for the rainy day from surplus money on hand using many avenues. In present times, banks are one of the primary money managers. By saving in debt instruments or which protect your capital, one manages to “save” money for the future. But is that still true? What if somebody tells you that your savings bank is actually losing money? This post is sure to get you interested in Interest and Investing!
The primary reason for “saving” – be it a savings account or a fixed deposit in banks, post offices etc., is to not only protect the money from physical vagaries (like theft, natural calamities etc.) but from an unknown hand called Inflation.
What is inflation? Simply put, this is the purchasing power of money getting eroded. You may have heard from your father, grandfather or your uncle that in “those” days Rice was 2 Rupees per Kg. But today it is at 12 Rupees. What happened meanwhile and why did this happen? The answer is inflation. In technical terms inflation is too much money going behind too few goods like the BDA auctions sites in Bangalore – the highest bidder gets the site.
The main reason banks would need to give your INTEREST, is to primarily BEAT this inflation so that your purchasing power of the money at least remains the same year after year.
Now let us apply this theory to our salaried professional who is a hard core tax paying person. He has 1000 Rupees in savings account. The published inflation is at 6%. The bank pays 3.5% on your savings account. So our man is loosing 6 minus 3.5%, which means year on year, he is losing 2.5%. His money is diminishing despite a national banks capital protected account!!!
Want to move that to a fixed deposit? Well they yield 8% for an year. Remove the 6% from 8%, simple arithmetic would give you 2% profit. IS IT SO…what about the income tax? If you are like most middle class in the 30% + bracket, your numbers are:
Bank interest = 8% = Rs. 800 ( for the Rs. 10,000 invested)
Income tax on 800 Rs. @ 30% is Rs. 240
What you are left with is Rs. 560 or 5.6%
Now remove the inflation @ 6%
Your returns are -0.4%!!
The same holds true for most fixed tenure instruments, which are expected to protect the capital of the investor.
If earning money is difficult, protecting it is much more tougher, isn’t it?