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Why leaving your money in a bank is a bad idea?

Most Indian families have the bulk of their household savings and assets in a bank account. We believe that this is the worst thing that you could do for your money Not only are you not going to get rich like this, but you are actually losing money over the long run. Not to mention, the bank is taking advantage of your money to make money at your expense. Lets tell you more...

First of all, let us acknowledge that depositing money into a bank account is great because of the convenience and security that it offers us. Banks are a great mechanism to transmit money from your account to say your mobile phone company or your electricity provider or paying your children's tuition fees by cheque. You receive your monthly salary and that goes directly into your bank account. And this is where the problem begins.

If you want to know why this is a problem, its because of our inertia. Experience has shown that most Indian families don't do anything with their surplus money apart from leaving it in the bank account which is often because of a lack of financial awareness. Here are 3 problems you are exposing yourself to if you are guilty of this inertia:

1. You will not get rich
2. You are making your bank rich
3. You will lower your standard of living

1. Fixed deposits
2. Liquid funds
3. Mutual funds

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1. You will not get rich: Your bank pays you 3.5% for your money. This is a very low rate of interest earned and will definitely not make you rich, compared to other safe but higher return options you might have access to. Also, you will pay taxes on this return, so net net you will likely end up with a little higher than 2% return only. How will that make you rich?
2. You are making your bank rich: Yes! And no bank is going to tell you about it. While the bank pays you 3.5% interest, the same bank will loan out that money at a minimum of around 8%-10% (rates current as of June 2009). This is a huge spread that you are letting the bank earn at your expense, and this is why your bank manager will always encourage you to deposit money into your account
3. You will lower your standard of living: 3.5% return is much lower than what the long-term rate of inflation has been in India. Inflation is basically the general increase in the level of prices in the economy. Most economies, especially growing economies like India have a tendency to experience inflation. It means that while you earn a return of 3.5%, the prices in the economy, due to inflation, are generally going up at around >5%. This negative spread between your earned return and inflation hurts you by reducing your ability to purchase goods and services. Over a period of time, you will lower your standard of living because you will not be able to afford the items that add to your quality of life

So what should you do with your money?

Well, depending upon your financial situation and how quickly you need access to your money for your expenses or financial goals, you might want to consider the following 3 simple options that can offer you a better after-tax return than your bank account. As always, understand the risks before you invest in any of these.

1. Fixed deposits: FDs will earn you a higher rate of return than a simple savings bank account. Current rates (as June 1009) are approximately 8%-9% pre-tax depending upon duration of the FD. The net return is much higher than a savings account, and you don't pay any fees to buy an FD
2. Liquid funds: Liquid funds will also usually give a higher return than a bank deposit and you will also not pay any entry fees. These are suitable for investors with low risk appetite and a short-term investment period where you need access to your money quickly
3. Mutual funds: If you do not need the money for a long period of time, say at least 3-4 years, then consider investing through equity mutual funds. Depending upon your risk profile, you might want to start with balanced funds or high quality large cap funds. Equity mutual funds will be a higher risk than investing in the other two options mentioned above

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