Best Savings products

Types of savings products

In this section we will outline the following types of savings products:

1. Life insurance
2. Bank deposits
3. Mutual funds
4. Shares
5. Savings products
6. Bonds
7. Post office savings
8. Gold and silver

Life insurance

Many life insurance products, along with the primary life cover, come with a savings element. The savings component of the premium is invested by the insurance company on behalf of the policyholders and the returns earned are shared among policyholders in the form of bonuses.

In participating plans like endowment plans and whole life plans the insurance company takes the investment risk. In ULIPs the investment risk is borne by the policyholder.

Besides meeting protection needs, life insurance products are an excellent choice for investors to invest funds for long-term goals like children’s education and marriage, retirement and others.

Bank deposits

Bank deposits are one of the oldest and most preferred savings products. They are an instrument where an individual has to invest a lump sum amount with a bank for a fixed tenure at a fixed interest rate. Bank deposits are commonly known as fixed deposits or term deposits. Bank deposits are considered safer than many other investment products and they offer decent returns. In a bank deposit the amount, tenure, interest rate and method of payment of interest are decided at the inception of the deposit.

The investor can choose from three types of deposits:

Traditional deposits: With this type of deposit the bank pays the interest on the depositor’s fund on a monthly/quarterly/half yearly/yearly basis as chosen by the depositor at the time of making the deposit.

Cumulative deposits: With this type of deposit the bank pays the principal and the total interest at the end of the term. In a cumulative deposit the interest is normally compounded on a quarterly basis.

Recurring deposits: With this type of deposit the investor deposits a specified amount every month over a chosen time horizon. These deposits are ideal for people looking to accumulate money for financial goals like children’s education, marriage, buying a vehicle etc.

The interest rate on these deposits varies with the maturity period. Bank deposits provide returns in the form of an interest payment. The principal amount deposited with the bank at the time of opening the deposit is returned back to the depositor on the maturity of the deposit.

Mutual funds

A mutual fund is a fund that brings people with a common objective together. Money collected from these people is invested on their behalf and the returns are shared back amongst them. Mutual funds are managed by Asset Management Companies (AMCs). The AMCs invest the money according to the objective of the scheme in equities, debt instruments, money market etc. The AMCs employ qualified and experienced fund managers (also referred to as portfolio managers) who are responsible for investing the funds based on the type of fund (or scheme) that is chosen by the investor.

The main advantage of investing in mutual funds is risk diversification. The individual’s funds are spread over different securities to get optimum returns with minimal risk.

Mutual funds provide two types of income:

• regular income in the form of dividends declared by the mutual fund scheme from time to time; and

• capital appreciation where the mutual fund units are sold at a price higher than the price at which they were bought.

However, there can also be capital loss in mutual fund investments. If the financial performance of the companies in which the mutual fund scheme has invested is poor, it will lead to a fall in the share prices of those companies. This in turn will reduce the value of the investments of the mutual fund investors who have invested in the units of that scheme. You can see therefore that the performance of a mutual fund scheme is based on the performance of the securities in which the scheme has invested.

Shares

Equity shares represent ownership of a company. Whenever a company wants to raise money for its growth, set up a new production unit, acquire another company, acquire technology, working capital etc. the company may offer shares (ownership in the company) to the public.

Example

Let’s assume a company’s total capital of Rs. 10,00,000 consists of 1,00,000 equity shares of Rs. 10. If the owners (promoters) of the company want to raise money for the company’s expansion by offering 10,000 shares to the public; then it is said that the owners are diluting 10% of their ownership in favour of the public. If an individual acquires 100 shares from the total 10,000 shares on offer, they are said to have acquired 0.1% (100 shares out of a total 1,00,000 shares) shareholding (ownership) in the company.

Once the shares are offered to the public, the buying and selling of shares takes places through stock exchanges. Stock exchanges act as intermediaries and offer a trading platform for the buying and selling of shares between individuals. However, individuals cannot directly buy or sell shares through the stock exchanges, they have to place their buy and sell orders through stock brokers (members) of the stock exchanges. The two main stock exchanges in India are the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).

Individuals who purchase shares have the right to receive a share in the company’s profits in the form of dividends. The profits are distributed in proportion to the number of shares held by the shareholders.

Equity shares provide three types of income to the investor:

Dividend income: The company may share a portion of the profits that have been earned with the shareholders in the form of a dividend declared from time to time.

Bonus shares: When a company accumulates large cash reserves, it capitalises them by issuing bonus shares (free shares) instead of distributing them as dividends. Bonus shares are issued in proportion to the existing equity share capital of the company. The issue of bonus shares is a vote of confidence from the management to its shareholders about the good financial performance and future prospects of the company.

Capital appreciation: When shares are bought at a lower price and sold at a higher price, the difference between the two prices is known as the profit or capital appreciation.

Bonds

Bonds are similar to bank fixed deposits in that they provide regular income to the investor in the form of interest payments. However, bonds can also be traded between buyers and sellers. Apart from banks, bonds are also issued by the Government, companies and other institutions to raise money from the public. In simple terms, a bond is a loan provided to the issuer by the investors. Hence in the case of bonds, the investors are the lenders who receive interest on their loan. At the end of the tenure the original amount (principal) is returned back to the lender.

There are different kinds of bonds in which the investor can invest, these include:

• Corporate bonds;

• Government securities (G-secs);

• Commercial paper; and

• Treasury bills.

Post office savings

Post offices in India offer several savings products such as:

• National savings certificate (NSC).

• Kisan vikas patra (KVP).

• Public provident fund (PPF).

• Post office savings account.

• Recurring deposit account.

• Time deposit account.

• Post office monthly income scheme (POMIS).

• Senior citizens saving scheme (SCSS).

These are all products in which an individual has to invest a lump sum amount for a fixed period of time (except for recurring deposits where regular investments are made and savings accounts). The investor earns a fixed interest rate which is specified at the time of investment.

Investment in gold and silver

India is one of the world’s largest importers of gold, and gold and silver are one of the most popular and oldest savings instruments in India. There are various ways of investing in gold and silver, the most popular in India being jewellery. Other ways of investing in gold and silver include bars and coins sold by banks and jewellers. Apart from physical gold, investing in gold in electronic format is also increasing. Gold ETFs (exchange traded funds) are like mutual funds in which gold units can be traded in electronic format on a stock exchange, just like shares. In gold ETFs one unit represents one gram or half a gram of gold.

Reasons for investing in gold and silver include:

• Good returns;

• Portfolio diversification;

• Hedge (protection) against inflation; and

• Insurance against uncertainties.

Features and benefits of savings products

We will now look at the main features and benefits offered by the various savings products and how these features influence their suitability to meet a particular individual’s needs.

Capital or income growth

Some savings products provide regular income (interest paid by a bank fixed deposit), some provide capital growth (gold) and others provide a mixture of the two (equity shares). All of these products will be discussed later in the chapter. Remember that the objective of the individual investor should be matched with the investment profile of the product.

Guarantees

Some products are available with guaranteed returns, some provide variable returns and others provide a mixture of guaranteed and variable returns. So products should be chosen based on the risk profile of the individual client.

‘Lock-in’ period

Most savings products have a stipulated ‘lock-in’ period during which the funds cannot be withdrawn by the individual. Therefore the client should carefully determine their needs and the length of time for which their money will be inaccessible before deciding which product to invest in.

Penalties

Penalties are associated with the premature withdrawal of funds from fixed term contracts. This is an important consideration which needs to be evaluated before investing in such products.

Risk

All savings products carry a level of risk and these can be rated as low risk, medium risk and high risk. Low risk products offer lower returns compared to high risk products. Hence the products should be carefully chosen based on the individual’s circumstances and their risk appetite.

Buying and selling mechanisms

Buying and selling mechanisms are important in two ways: convenience to the individual investor and the speed of the transaction.

Flexibility

Flexibility refers to the ability to switch between different forms of investment, the payment of variable contributions, and even to temporarily stop making contributions altogether. These features can easily increase the attractiveness of the product. Flexible products also allow for the partial withdrawal of funds without affecting the product in force. Generally, the greater the product flexibility, the more suitable it is. However, features like allowing a temporary break in contributions and partial withdrawals can result in lower long-term investment returns.

Example

Unit-linked insurance plans (ULIPs) allow policyholders to switch their investments from one fund (equity) to another fund (debt). They also allow policyholders to take premium holidays (temporarily stop making contributions) and to make partial withdrawals.

The need for savings/investment advice

The savings needs of each and every individual are unique. Most individuals do not make wise decisions in terms of investments as they will often invest in certain products without fully evaluating the product features and their own financial needs. These decisions are often taken at random, based on peer influence or even as a last-minute resort to save on taxes.

In this section we will discuss the two major reasons for which professional advice should be taken by individuals with regards to their savings and investment needs.

Ignorance about the

financial planning process

Individuals are often unable to identify their own savings and investment needs. They concentrate more on meeting their short-term needs rather than on their long-term requirement for funds. Also, the tendency to spend rather than save is greater as the immediate appeal of consumer goods is more apparent and persuasive than the intangible, future benefits of saving.

Professional insurance agents help individuals by taking them through the financial planning process in which they can identify their present and future financial needs. Some of the long-term goals an individual may have include saving money for their children’s education and marriage, saving money to purchase a house, or repaying the existing home loan at an earlier date and planning for their retirement.

Ignorance about the full range

of financial products available

The majority of people are not aware of the various savings and investment products that are available in the market. As a result they are unable to select suitable products which meet their financial needs.

It is here that the insurance agent can offer assistance by:

• having a good knowledge of the various products that are available;

• matching the products with the individual’s financial needs; and

• evaluating the tax efficient returns of the products, taking into account the tax treatment of the products and the tax eligibility criteria of the individuals.

In summary, agents should guide the prospective investor using their financial planning skills to offer quality advice thereby encouraging saving in a purposeful and needs-based manner, and not necessarily just for maximizing returns. 

Anand Khemka
+91-9910936925
+91-8287041341