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Saving for the future: What is the right way?

Saving for the future: What is the right way?

By Shubhra Agrawal

Movies like Zindagi Na Milegi Dobara give people goals of a dream life: earn money till the age of 40 and retire. However, according to a recently released RBI report, more and more Indians are retiring poor with no pension and more debt in their pockets. One major reason for this phenomenon is said to be financial illiteracy.

Financial literacy: Why is it important?

Financial literacy is having the right knowledge to make financially responsible decisions. It helps families make the right decisions when they are buying a new car, securing funds for their children’s education or ensuring a regular income at retirement.

An efficiently working economy will have high financial literacy and financial stability. It enhances the ability of people to ensure economic stability for their families. There is a need to increase financial stability in the lower income groups and economically weaker sections.

However, there is a far pressing need to induce the necessity of financial literacy in the millennials, who are economically more active, but also more fragile in dealing with personal finances. For example, with the advent of online shopping, there is now huge scope for young shoppers to use and exceed their credit limit, thus accumulating a lot of debt. Many of these consumers have little to no knowledge of how credit works and its potential impact on their financial well being.

Ignorance leads to poor decisions

For an average Indian, financial literacy is not yet a priority. India accounts for 17.5% of the world population, but over 76% of its adult population does not understand basic financial concepts. 

Household wealth is stored in the form of real estate and gold, even by the poorest 40% of the country. This trend seems to be continuing even amongst the younger families. Further, institutional borrowing seems to increase with age; and with no pensions, many old people are left with a debt hanging around their neck. On the other hand, in developed countries, loans are taken early on and hence mortgages reduce after retirement.

Debt behaviour in India

Medical emergencies are one of the reasons why the elderly require loans. According to reports released by the RBI, such unsecured loans make up nearly 56% of all liabilities for Indian families, much higher than China at 26%, US (13% ) and Germany (24% ). Some of these risks can be mitigated by strengthening the public welfare system and improving the public healthcare system.

Most Indian families do not focus on savings. Hence, they are forced to use debt to deal with emergencies, such as property damage due to a natural disaster. The interest rates on unsecured debt are very high and require large collateral.  As a result, households prefer to invest their savings in securing gold, that can be used as collateral. 

Gold loans account for 8% of an average family’s liabilities. 11% of the average family income in India goes into buying gold. In China, only 0.4% of the income is spent on gold. Gold is an ineffective investment. There is no guarantee that the value of gold would increase and it does not protect families from inflation or give dividends. Hence, gold will invariably give poorer returns. 

Savings, investment and insurance

Due to the Pradhan Mantri Jan Dhan scheme, 73% of families now have bank and pension accounts. But they hold only 5% of their total wealth as of now. Most middle-class families use their savings account as storage spaces for all their money—at least the amount left after buying gold and land. Even though this ensures high liquidity, it gives lower returns. On the other hand, investments would yield higher returns, but usually, come with fluctuating values and lower liquidity.

Families must balance their money between the two available options. Leaving enough money for emergencies in the savings account, funds required for long-term goals must be held in investments based on risk profile. Moreover, the investments must be reviewed periodically to ensure profitability. A Systematic Investment Plan or SIP is an example of a smart and hassle free mode for investing money in mutual funds. There are a lot of mutual funds in the market, each designed for specific purposes. To choose the right SIP, financial literacy is necessary.

The traditional savings system that exists in India is under pressure from the shifting social norms and changing economic conditions. The government must focus on financial literacy to ensure a better economic future for families across the country.

Featured Image Source: VisualHunt

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