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Saving money alone will not make you rich

Inflation eats away at your savings, bit by bit. Historically, inflation in India has always been at a far higher level than in the developed countries

Making Your Money Work

According to the dictionary, income that is not spent is saving. If you don't spend ten per cent of your monthly income and just keep the cash in a box, then you are saving money, no question about that. It's a simple concept, but by itself, it doesn't get you very far.

The basic reason for that is that money doesn't retain its value. Prices rise and what was worth a hundred rupees last year is probably worth ten or twenty rupees more this year. Inflation eats away at your savings, bit by bit. Historically, inflation in India has always been at a far higher level than in the developed countries. Over the last thirty years, it has varied over a wide range, but has rarely fallen below five or six per cent per year for a sustained period. The long-term average over this entire period is about eight per cent.

Eight per cent doesn't sound all that harmful. It just means that something worth ₹100 becomes ₹108. However, that's the annual rate. The inflation rate is a compounding rate, and the inflation of one year feeds into that of the next year, and so on. This means that if you had saved ₹1 lakh in 1982 and just kept it in a drawer as cash all long, then it would be worth no more than ₹8,200 today, just 1/12th of its original value!

And don't think that the future is going to be any better. Currently, despite all the efforts of the Reserve Bank, inflation has stayed above seven per cent. Economists now say that high inflation is now 'structural', meaning it's integral to the Indian economy and will likely stay that way.

And that's why we need to not just save, but also to invest our savings. Investment means putting our money into some form whereby it will yield some gains. Most of us are familiar with the 'types of things' that we can invest in. These 'types of things' could be property, gold, bank deposits, shares and deposits. Anything into which we can put in money and have it grow can be called an investment.

Of course, just matching inflation should not be the goal of any smart investor. Anyone who takes the trouble to learn some basics and applies them sensibly, should be able to earn more than enough to retain the value of their money. Investments can become an independent source of income. And if you let this sum accumulate instead of using it as income then it can grow into a serious amount of wealth.

Take the example above. Suppose that same ₹1 lakh had been invested in 1982 in the shares of a group of leading companies so that their value grew along the same rate as the BSE Sensex. The money would today have grown to ₹37 lakh! This is far ahead of the rate of inflation. A sum of ₹37 lakh can buy you a lot more than what ₹1 lakh could have bought you in 1982. Investing well over long periods of time will not just save you from inflation-- it can also make you rich.

But investing can be as risky as it can be rewarding. Newcomers who start investing with over-optimistic expectations, and without enough knowledge or caution always face the biggest problems.

This article first appeared in March 2014.