Rethinking Traditional Savings Habits: A Modern Approach to Personal Finance in India

Rethinking Traditional Savings Habits: A Modern Approach to Personal Finance in India

Indian households have always been known for their high savings rates, and for good reason - be it gold purchases during festivals or monthly savings towards fixed deposits, Indian families have been taught financial prudence that has seen them through decades of financial uncertainty, a lack of financial instruments, and even the financial risks of modern-day living. Such habits were valuable in the past and continue to be so in the present, though some of these practices may need refinement in light of new financial instruments and financial goals that have emerged in recent years.

This is not to discourage Indians from practicing the financial habits of their ancestors, but to encourage building on what has worked well for generations, to incorporate financial instruments that have greater scope for growth, and to include other financial planning features that have been ignored for too long. The following article offers five areas of financial planning advice that can benefit Indian households, as well as five financial practice refinements that can help in securing an individual's financial future.

1. Gold as an investment option in Indian households

Gold has a special place in the heart of every Indian. Be it during a wedding, Dhanteras or Akshaya Tritiya (a Hindu festival marking the start of the New Year) or even as a hedge against inflation or economic downturns, gold has always held a place in the financial as well as ritualistic life of Indians. Gold has always been popular in India, a fact that continues to hold true even today.

The Case for Gold

As a financial instrument, gold has always held value - it has generally maintained and increased its value over time and holds value even during periods of economic instability. As a financial instrument, gold is a safe and universally accepted store of value.

The Downsides of an Overly Heavy Allocation to Gold

While gold has many virtues as a financial instrument, there are several reasons why Indians should limit their allocation to gold:

Gold cannot provide any returns or yield, unlike equities or even fixed deposits. Additionally, gold cannot be directly spent - it must first be sold, and the sale proceeds can then be used.

Gold allocation of any size entails carrying and/or storing gold securely, and the cost of doing so can sometimes outweigh the benefits. Gold prices can sometimes be highly volatile in the short term, and it is easy to buy gold at a higher price only to sell it at a lower price later. Gold must also be converted to cash before it can be spent, and this conversion entails additional costs.

While gold allocation should never be very heavy (ideally no more than 5-15% of an individual's net worth), there are more attractive alternatives to direct allocation to gold that can offer far greater flexibility and yield. Sovereign Gold Bonds and Gold ETFs are excellent substitutes that offer investors exposure to gold prices without the hassles and additional costs of storing gold.

2. Fixed Deposits as a preferred savings vehicle

Fixed deposits are a preferred savings vehicle among Indians of all ages, and for good reason - the assured returns and security of fixed deposits make them an attractive option that have seen generations of Indians through financial crises. For most Indians, fixed deposits are synonymous with safety.

The Case for Fixed Deposits

Fixed deposits are an appropriate savings vehicle for any individual holding money for the short term (anything less than five years). As mentioned previously, fixed deposits offer a safe and reliable source of returns, and the assured returns of fixed deposits far outweigh the risks of other financial instruments for the short term.

The Long-Term Risks of Fixed Deposits

The problem arises when fixed deposits are used as long-term savings vehicles (anything more than seven to ten years). Most individuals who opt for long-term fixed deposits fail to factor in inflation and taxation when calculating their returns from a fixed deposit.

For instance, if an individual invests in a fixed deposit that offers a 6.5% annual interest rate, but inflation for the same period is at 5.5%, the real returns of the fixed deposit (after adjusting for inflation) would be just 1%. Additionally, the interest income earned on a fixed deposit is added to the investor's taxable income and taxed at their applicable income tax slab rate, further reducing the take-home returns. Thus, fixed deposits are actually a poor long-term savings vehicle as they fail to keep up with inflation and fall short when it comes to adjusting for taxes.

The Case for Market-Linked Instruments

When it comes to long-term savings and retirement planning, market-linked instruments such as equity mutual funds and the National Pension System are much better alternatives as they offer greater scope for returns and can keep up with - and even surpass - inflation. While market-linked instruments are generally riskier and more volatile in the short term, their volatility decreases significantly in the long term (anything more than seven to ten years), and their returns generally greatly outweigh those of fixed deposits once inflation and taxes are factored in.

Recommendation: Fixed deposits are an appropriate savings vehicle for the short term. They are a great tool for saving towards short-term financial goals, as well as an appropriate vehicle for emergency savings (these should ideally always be in the form of liquid or ultra-short-term deposits). For long-term savings and retirement planning, however, market-linked instruments should be a bigger allocation.

3. The pitfalls of promotional sales

Promotional sales are a part of Indian shopping culture. They are widely anticipated by Indians, and they are also widely abused by them. During these sales, there are numerous offers and attractive-looking discounts that appear to be good deals, which encourages Indians to go on spending sprees.

While there are good deals to be had during sales, it must be noted that most Indians will end up spending far more than they intend to during a sale because they fall for the marketing tactics used by sellers. Additionally, they are far more likely to purchase items that they would not have bought otherwise simply in order to take advantage of a sale

Why Are These Items Bought?

There are several psychological aspects to these impulsive purchases:

Many Indians fall victim to anchoring during sales, whereby they get tempted by a large discount and purchase an item that they would not have bought otherwise.

Many Indians have the tendency to procrastinate when it comes to buying things, and sales act as a motivator to purchase items that they had intended to buy but did not buy on time.

Many Indians also fall victim to loss aversion, whereby they are motivated to buy an item because not buying it means missing out on a good deal.

As a result, most Indians tend to spend significantly more money during sales than they would have otherwise.

Recommendation: Every individual should have a budget or a list of items that they intend to buy during a sale, as should only buy items that are on their budget list during a sale, and should avoid all other items. If a person wants to make an unplanned purchase during a sale, they should wait for 24 hours before making the purchase, in order to assess whether or not they genuinely want to make the purchase.

4. The importance of long-term retirement planning

Indian families have traditionally saved money for large expenditures such as marriages, homes, cars, and education, and to a lesser extent, family vacations and festivals. However, the importance of planning for retirement has been overlooked due to the belief that one can solely rely on one's employer-provided provident fund for one's retirement years.

The Case for Milestone-Based Saving

It must be noted that planning towards major expenditures, or milestone-based saving, is actually a fantastic financial planning technique that has helped Indians through financial crises for generations. It is this form of financial planning that has allowed families to put together large sums of money in a short amount of time in order to fund a daughter's marriage, for instance.

The Case Against Ignoring Long-Term Retirement Planning

Planning for retirement, on the other hand, has long been ignored by Indians. There are several factors that contribute to this, namely:

Most salaried Indians assume that their provident fund contributions will be enough to fund their retirement, without taking into account inflation or longevity risk.

Most individuals are unfamiliar with voluntary retirement savings products.

Many individuals wrongly believe that they can start planning for their retirement at a later stage in life.

The earlier one starts planning for one's retirement, the less one has to save in order to meet one's retirement needs. For instance, a young individual who starts saving INR 10,000 a month at the age of 25 will be able to retire with significantly more money than an individual who starts saving INR 25,000 a month at the age of 40, simply because of the additional time that the former has had to let her savings grow. Thus, it is critical to start saving for retirement early, even if it is just INR 500 a month.

Recommendation: In addition to milestone-based saving, every individual should set aside a separate savings allocation for their retirement corpus, and start saving towards it regularly in order to allow their retirement corpus to grow significantly over time.

5. Tips for developing a balanced financial strategy

Indian households' savings habits are not without their flaws, and there is room for improvement in how they approach their financial planning. Below is a summary of the refinements that can be made to these financial habits that can result in significantly better financial outcomes:

Modern Refinement: A diversified portfolio with a small allocation to gold holdings

Refinement 2: Traditional Habit: Heavy allocation to fixed deposits for long-term savings

Modern Refinement: Fixed deposits only for short-term savings; market-linked instruments for long-term savings

Refinement 3: Traditional Habit: Impulse buying during sales

Modern Refinement: Avoid unplanned purchases during sales

Refinement 4: Traditional Habit: Saving towards large expenditures only

Modern Refinement: Saving towards large expenditures as well as retirement planning

Refinement 5: Traditional Habit: Reactive financial planning

Modern Refinement: Proactive financial planning with regular reviews

A Sample Roadmap

Individuals considering applying these refinements in their financial planning can begin by adopting the following roadmap:

Set up an emergency corpus that ideally covers six months of expenses in liquid or ultra-short-term fixed deposits.

Take a stock of gold holdings, and consider switching a part of gold holdings to gold ETFs or Sovereign Gold Bonds, if any.

Assess long-term savings and consider allocating them more towards market-linked instruments.

Set aside a portion of income toward retirement savings, even if it is a small amount.

Adopt a purchase discipline during sale events.

Conclusion

Personal finance in India is evolving rapidly, and younger Indians find themselves in a far better financial position than their parents and grandparents due to a combination of high savings rates as well as a greater financial literacy when it comes to financial instruments, financial planning, and financial markets. With the ability to take advantage of their family's financial habits as well as the new opportunities on offer, today's Indians can truly take advantage of a far greater array of financial opportunities than their predecessors in order to secure a financially stable future for themselves and their families.