Saving products are relatively safe in protecting the principal capital and offering a low to a modest return on interest payment. In addition, saving accounts are mostly liquid as a cash withdrawal is easily accessible.
Avoid any such scheme where there is a lock-in period, or returns are subject to market movements, for example, tax saving schemes, equity stocks, equity mutual funds, bonds, debentures, etc.
Types of Saving Products
- Savings account offered by a bank or post office.
- Recurring or Fixed Deposit schemes offered by a bank or post office.
- Money market Mutual Fund Schemes.
- Debt Mutual Fund Schemes.
Regular savings accounts, traditionally called passbook accounts, are ideal if you plan to make frequent deposits and withdrawals. They require little or no minimum balance and allow you to withdraw money on demand. The trade-off for this convenience is that the interest you earn will be low compared with investment plans.
You may receive a passbook that records deposits and withdrawals, but typically, you will get a monthly or quarterly statement in the mail. Commercial banks, savings and loan associations, and other financial institutions offer regular savings accounts.
Benefits of Savings Account
- Access and availability: Savings accounts are easy to open. Unlike long-term investment accounts, you can withdraw and deposit money anytime within certain specified limits, at ATMs, or via 24-hour online access. Many institutions will allow you to link your savings account to other accounts, like a Fixed or Recurring Deposit account, which can help you to avoid costly overdraw fees. This also allows you to transfer funds from one account to another quickly.
- Protection: In 2020, the government of India proposed to hike the bank deposit insurance in scheduled commercial banks from Rs 1 Lakh to Rs 5 Lakhs per account. According to the RBI guidelines, deposits with all commercial and cooperative banks are insured under the Deposit Insurance and Credit Guarantee Corporation (DICGC). Only Primary Cooperative Societies are not covered under DICGC.
- Liquid Money: Savings accounts deal in cash, so you don’t have to worry about selling investments or making other complicated moves to access your money. Money in a saving account is highly liquid.
- Interest Generation: Historically, interest rates in a savings account have been low compared to other investment products; still, it provides a nominal interest often in line with the inflation rate. The rates depend on the bank, but the national average is about 3-4 % per anum, with high-yield interest rates of up to 7 % during a higher inflationary period or per the monetary policy decisions.
- Low Initial Amount: Many savings accounts can be started with just Rs 500. Some banking institutions allow a savings account to be opened for as little as Zero balance, so you can begin saving with even a modest amount.
- Automated Debit Facility: Many financial institutions allow bills to be paid automatically out of a savings account without being subjected to withdrawal and transfer fees. This helps in avoiding late fees for missed payments.
Selection of a Saving Product
Several factors may influence your selection of a savings product. Some of these factors are:-
Rate of Return
The rate of return, also known as yield, can measure earnings on savings. The rate of return is the percentage of an increase in the value of your savings from earned interest. For example, you put Rs 10,000 into a regular savings account last year and made Rs 500 in interest. Then, the rate of return is 5 percent. To calculate the rate of return, divide the total interest earned by the deposit amount (Rs 500/ Rs 10,000 = .05 or 5 percent).
Compounding
It is the process in which interest is earned on the principal, i.e., the original amount you deposited and any previous interest amount earned. It is a multistep process for computing interest. First, the interest on the principal is calculated. Then, this interest is added to the principal. Next time when interest is calculated, the new, larger balance is used. Compounding may take place every year, every quarter, every month, or even every day.
The more frequently the interest is compounded, the higher the yield or rate of return would be.
Example: If interest is compounded yearly @ 5% p.a. on Rs 10,000/- then the interest amount would be Rs 5,000/- and the yield would be the same as the nominal interest rate, i.e., 5%. p.a. Remember, the nominal interest rate is the rate mentioned on a saving product.
Assuming the interest is compounded half-yearly, then @5% on Rs 10,000/- the rate of return would be higher.
Interest for first six months = Rs 250 (Rs 10,000* 2.5%)
Interest for next six months would be calculated on Rs 10,250 (Rs 10,000+Rs 250) and it would be Rs 256.25 (Rs 10,250* 2.5%)
Total interest for one year would be Rs 556.25 (Rs 250+ 256.25). This is higher than the interest where compounding is done annually.
The rate of return, if compounding is done half yearly, would be 5.56% (Rs 556 / Rs 10,000)
The difference may not seem like much, but compounding can significantly impact large amounts of money held in savings accounts for long periods.
Inflation
You should compare the rate of interest you earn on your savings with the inflation rate. If you open a savings account that offers 3 percent interest and the inflation rate rises to 6 percent, your money will lose value and buying power. Usually, the interest rates shown on savings accounts increase if the inflation rate rises. The biggest problem with inflation occurs if you are locked into a lower interest rate for an extended period.
Tax Consideration
Like inflation, taxes reduce the interest earned on savings. For example, you can find a savings account that would pay 7 percent interest. However, you may not be happy if you find that you have to pay taxes on that interest. You may look for tax-exempt and tax-deferred savings plans.
Liquidity
Check the savings plans you are considering to determine whether a savings account charges a penalty or pays a lower interest rate if you withdraw your funds early. Consider putting your money in a liquid account even if it earns lower interest. On the other hand, if you are saving for long-term goals, a high-interest rate is more important than liquidity.
Restrictions and Fees
Be aware of any restrictions on savings plans, such as a delay between when interest is earned and when it is paid into your account. Also, check for fees for making deposits and withdrawals. Find out any service charges you may have to pay if your balance drops below a certain amount or if you do not use your account for a certain period. These fees and service charges can add up significantly over a period.
Conclusion: Choose the right saving product and achieve Financial Freedom
Saving plans can help you get ahead financially. They can help you plan for the future, reduce spending, and ensure you are not overspending.
The benefits of saving plans are numerous. It can help you avoid unnecessary debt, save up for a rainy day, improve your credit score, and more.
Saving plans have become an essential part of life in the 21st century, and it is crucial to implement them to be financially secure.
