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  • Home » News » Banking » Understanding risks of over-saving without investing

Understanding risks of over-saving without investing

It is essential to maintain the right balance between savings and investments allocation to build your wealth

  • Adhil Shetty
  • Updated On - October 16, 2021 / 05:07 PM IST
Understanding risks of over-saving without investing
The most important reason for saving money is to allow you liquidity in case of a financial emergency.

Saving and investments are two crucial activities that help you achieve financial goals. So much so that people often take one for the other. However, that’s not correct. Savings and investments are two very different things. While saving usually indicates total income ‘minus’ total expenses, investment refers to deploying the savings towards efficient financial instruments to generate a higher return, which can help in meeting the short- and long-term financial goals.

The purpose of saving should be to maintain an appropriate level of contingency funds and to maximize wealth creation while also enabling you to achieve your financial goals. Simply put, saving is a good habit, but only provided you can use it to generate a higher return through investment. Over-saving and not using the saved corpus for investments can prove to be disastrous for your financial health. Let’s check out how over-saving is bad for you and how using the savings money in investment instruments can suit you more.

Perils Of Over-Saving Money

The most important reason for saving money is to allow you liquidity in case of a financial emergency. However, you need to set aside only a small portion of your total savings for the financial contingencies. The rest of the money needs to be invested to gain higher returns, or else it may destroy your chance of achieving your long-term financial goals. This is because most saving instruments, such as the savings bank account, or even FDs for that matter, may not be able to generate a positive real rate of return after accounting for factors such as inflation, taxes, etc. In other words, your actual return on investment may be much lower than the offered interest rate. This can cause your wealth to erode over time instead of creating more wealth.
This is how it happens.

How People Over-Save Money

Usually, banks offer a savings bank interest of around 3% per annum, which is lower than the prevailing inflation rate. Interest earned on savings account allows tax deduction benefit of up to Rs 10,000 (for Non-senior citizens) u/s 80TTA. Interest in excess of Rs 10,000 from a savings account is subject to tax at the applicable income tax slab rate. So, if you have Rs 5L in the SB account, at the end of one year, you will earn roughly Rs 15,000 against it. At 30% tax on the excess Rs 5000, your effective earning comes to Rs 13,500 in a year, or 2.7%. At 2.7% every year, it would take you roughly 26 years to double your investment. At 5.5% inflation, the value of the money would have fallen by over 75% of its current value by then.

Fixed deposits today are not much better. If a fixed deposit returns 5%, your post-tax returns would be 3.5% after 30% tax. At a 5.5% inflation rate, your real returns are a negative 2%, which means your capital is eroding instead of growing.

However, if the money kept in the savings account are invested in tax savings scheme u/s 80C, such as ELSS, ULIP, etc., then you can get a tax deduction benefit of up to Rs 1.5L and also earn a much higher return on investment than the savings account.

Sometimes people are unaware of the amount in their savings and current account as they may be spread across multiple bank accounts. If you hold multiple accounts, then it would be wise to see how much money is lying idle in these different bank accounts, and you may want to consolidate them into fewer accounts to avoid the problem of over-saving.

Savings Vs Investment: Getting The Balance Right

It is essential to maintain the right balance between savings and investments allocation to build your wealth. Start by calculating the size your savings fund needs to be in order to cover financial contingencies, medical emergencies, day-to-day expenses, etc. This will help you allocate funds for savings corpus. Next, chart out your short-term and long-term goals and split the excess amount into short and long-term investments in sync with your financial goals. Choose the appropriate investment instrument as per your liquidity requirement, risk appetite, and return expectation, and take factors like inflation and taxation into account as well.

Savings and investments should go hand in hand. If you earn more money, it should translate to higher wealth creation, but if you focus only on savings, it may lead to wealth erosion in the long-term. So, your savings should be invested wisely for a better return. And the more you can save, the more you would be able to invest towards achieving your financial goals!

(The author is CEO at BankBazaar; views expressed are personal)

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