Nirav Panchmatia's Blog

The Rich man’s bank accounts

In this article, let me introduce you to the rich man’s bank account. Yes, the financially well healed & High Networth Individuals (HNI’s) have a different avenue where they park their funds that they do not need temporarily.
Now where do you park the surplus money that you do not need immediately? You and I would, in all probabilities, park our surplus money in savings account of banks. The reason is that we want the money to remain safe and also we can’t invest that money because we might need the money anytime. Hence the best option that comes to one’s mind is the ubiquitous bank savings account that earns us a handsome return of 3.50% per annum.
Wait a minute, did I use the word handsome returns. In today’s inflationary times, when the purchasing power of our rupee is going down by 7 to 10% per annum, a 3.50% per annum return is in real terms reducing the purchasing power of your money, lying in your bank savings account, by 4 to 5% per annum. Yes, let me repeat this once again. The value of your money lying in the bank savings account is getting reduced by 4 to 5% every year in real terms. And you thought that you are actually earning interest on your savings bank account.
In reality, the money that is lying idle in our bank savings account is unknowingly a loan that you and I are giving to our banks at a paltry, minuscule low rate of 3.50% per annum. And what rate of interest does the bank charge us when we approach them for availing a bank loan. Currently, banks are charging interest rates ranging between 9% pa to 24% pa on various types of loans.
Now that was the case with short term surplus money at our disposal. Any surplus money that we might have beyond what we need in the immediate short term, one tends to park that money in Bank Fixed Deposits (FDs). Why? Same 2 reasons. Safety and because nowadays bank FDs are offering a handsome return of 8.5 to 9.50% per annum. (No no, you are mistaken. The 10% rate of return that you see being promised on huge hoardings or in the media is either meant for senior citizens or it is meant for FDs that have tenure of 500 to 1000 days. So your liquidity goes for a toss here. (Haven’t I mentioned before, on this blog to read the * and the fine print carefully?)).
Again, did I mention handsome returns of 8.50 to 9.50% pa? Sorry for the mistake. We forget to take into account the taxation and inflation factors here. So assuming a 20% rate of tax (on average; on FDs you are taxed at the income tax rate applicable to you) and a 7% pa rate of inflation (again I have taken this figure on the lower side; your real earnings from Fixed Deposit = 9.50% – (20% of 9.50%) – 7% = 0.60% per annum. Yes, believe it or not. In India, considering the present inflationary situation & the prevailing tax rates, a Bank FD on which a nominal rate of return of 9.50% is promised to you, you are actually earning 0.60% per annum real returns. In other words, your bank Fixed Deposit, giving 9.50% pa interest rates, is in  real terms, post inflation and taxes, growing merely at 0.60% per annum. Yes, I should admit that your capital remains protected and does not go down in bank FDs (unless in case of some co-operative banks).  Have a look at the graphic below:
What the bank charges you & what it pays you?

Type of Bank Loan Interest charged per annum Tax Impact
Home Loan 9.5% to 14% pa Tax deduction available
Car Loan 11.5% to 15% pa No tax deduction
Personal Loan 15% to 24% pa No tax deduction
Credit Cards 36% to 54% pa No tax deduction
Type of Bank Product Interest earned per annum Tax Impact
Savings Bank A/c 3.50% pa
Bank Fixed Deposits 8.5 to 9.50 % pa (1 yr FDs) Chargeable to tax as per your tax bracket (10% to 30%)
Average Rate of Inflation going forward 8 to 10% pa

The rich guys bank accounts
So what is the remedy? Most Indians (65% as per a recent survey) use bank savings account & Fixed Deposits as a preferred choice for parking their short & medium term money. There is simply no other option out there. Right…
WRONG. Where do you think the richer guys or HNIs who advised by their financial advisors or wealth managers, park their riches.
One, when it comes to parking very short term money that they might need any time but do not know when, Liquid & Liquid plus funds offered by almost all Mutual Fund companies is the most preferred avenue by HNIs or richer folks to park their short term surpluses and not your ubiquitous savings account.  So what are these liquid or liquid plus funds and how safe is my money in them. What about liquidity?
Liquid & liquid plus funds are the most liquid & least risky category of mutual fund products where one can invest or park temporary surpluses for even a day or two. Yes, liquid funds can be used to park money even for as little as 1 to 2 days. You can even park your money on Friday and withdraw your funds on Monday and earn interest for Saturdays & Sundays too. Sounds too good to be true…
Ok. Now what do you earn on liquid funds & how are they taxed? Well, currently, one can earn on an average 6.50 to 7.25% per annum on well chosen liquid funds & the returns earned on liquid plus funds are taxed @ 14.67% (compared to 30% on Bank FDs). How safe is your money in liquid funds? Well, the entire banking industry uses liquid funds to park its surplus funds. Does that say enough about their safety? Only, not all liquid funds are equally safe or give same rate of return. And there are more than 50 liquid funds out there in the market. So exercise discretion and take advice of your wealth manager to help you choose the right liquid fund for you.
Short term Debt Funds: OK, what about the Bank FDs. Does mutual fund industry have an answer to the high safety and so called handsome returns provided by Bank FDs. Off course it does. Short term debt funds offered by mutual fund industry are currently offering returns in the range of 8.50 % to 9.0% per annum and again, are taxed @ 14.67%. If debt funds are chosen properly after evaluating its portfolio & consulting your financial advisor, they are very safe instruments if entry & exit is timed correctly. Only one caveat here… The returns from debt funds are indicative and not guaranteed like Bank FDs. But on the positive side, short term debt funds are more tax efficient and more remunerative and also offer liquidity beyond 3 to 6 months.
Monthly Income Plans (MIPs): Now, if you have a slightly longer investment horizon (say 2 to3 years) and if you can take some risk with your money, Monthly Income Plans or MIPs offer average returns in the range of 10 to 12% per annum. MIPs invest 75 to 85% of your money in safe debt instruments and only 15 to 25% of your money is invested in equity. Here is where the extra return comes from. Well chosen MIP is another weapon in your armoury against inflation.

Poor Man’s banking
 products
Expected Return
(% pa)
Rich Man’s banking
products
Expected Return
(% pa)
Incremental
 earnings
Savings Bank A/c 3.50% pa Liquid Plus Funds 6.0 to 7.0% pa 3.50% pa
Fixed Deposits 9.50% pa pre tax;
6.65% pa post tax
Short Term Debt Products 9.50% pa pre tax;
8.11% pa post tax
1.5 to 2% pa
Monthly Income Schemes (MIS) 8.50 to 9.0% pa MIPs 10 to 11% pa 2 to 3.5% pa

Conclusion
So know we know where the rich guy or HNI parks his money. Not in banks or FDs but in a combination of liquid funds, debt funds & MIPs. By doing this, he earns 2 to 3 % higher returns & pays 50% less tax. Now you know why the rich guy is rich?
Sound Investing…………………


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