Musing 2: Don't Ever Save

MUSING 2: DON’T EVER SAVE

Your Piggy Bank Eats Money.   Let’s say you get attracted to a real cute dress at H&M (Hennes & Mauritz) at the nearby mall but don’t have money to buy it because it costs Rs 5000. Your fiscally prudent parents ask you to save out of your pocket money in order to buy the dress after some time. So you start saving Rs 500 out of your pocket money each month and keep putting it in your piggy bank. After 10 months you rush to the H&M outlet to buy the dress but find that you fall short by Rs 500 since the dress costs Rs 5500 now. What happened? Did your piggy bank eat Rs 500 over last 10 Months? Or, the price of the dress went up by Rs 500 in this intervening period? Actually, it is a bit of both-yes, your piggy bank actually eats money. No kidding.

          What actually happened was that the purchasing power of your money got eroded by a phenomenon called Inflation which is nothing but a rise in prices of goods and services over time. In India we look at basically two types of Inflations-Wholesale Price Inflation (WPI) and Consumer Price Inflation (CPI). The WPI compares the wholesale price of a basket of 697 goods (Manufactured products, food items, fuel and water) month on month, whereas the CPI compares the price of a basket of 260 items of goods and services at retail customer level, month on month. We, as common persons should worry about Retail Inflation which is based on CPI. In India, it is the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) which sets the Inflation targets which are flexible but generally within a range of 4% plus/minus 2%.

So if the dress at H&M, which sold at Rs 5000, has gone up to Rs 5500, the inflation is up by 10%. Simple? Well, all you need to remember is that overtime nearly all the items/services you will buy or consume will get costlier by amounts corresponding to Retail Inflation.

          The fact of the matter is that irrespective of how much we earn, it can never make us rich. We will create wealth only if we can put our saved money to work in a manner that it keeps generating Real Returns overtime, meaning returns obtained after catering for Inflation. This brings us to a very fundamental conclusion-we must put our hard earned/saved money to work in such a manner that it keeps on giving the value which beats inflation or in other words one should not merely save money but instead invest it.

Clearly, your piggy bank cannot do it. But then what could? We will tackle this question in detail later but suffice to say at this stage that in India, the rate of Inflation over next decade is likely to be around 5-6%, as per the forecast of the International Monetary Fund (IMF). Hence wherever we invest our money it must give us a rate of return more than 6% or else like our piggy bank, the money will be eaten.          Even keeping our money in bank Savings account will not be good enough where one typically gets a return of just 3-4%.

          The ubiquitous Rupee draining power of Inflation gets even more severe in sectors of Real Estate and education-two areas on top of the mind of every parent and student. In Mumbai, for example, the price of per square foot of land has gone up by 2205 times in last 55 years. Similarly, the money required to obtain a two year MBA degree has gone up from Rs 3 Lac in 1999-2000 to nearly 25 Lac today.

Key Chapter Takeaway     

·        The Mantra of saving has to shift to Investing and wisely too, to beat the Rupee draining power of Inflation.

·        Wherever we invest our money, it must give a rate of return of at least 6%. The avenues to achieve the same will follow in subsequent musings.