A savings account is a suitable option for keeping emergency cash. However, there are other alternatives to keep your emergency corpus which you may keep aside for any kind of financial emergency or unexpected liquidity requirements. Considering the availability of credit cards and instant loans to meet liquidity requirements, you may keep an emergency corpus amounting to expenses for a month in the savings account. The interest earned on savings account usually ranges between 2.5-7%1, depending on the amount of savings. Considering the inflation rate of 6.77% as on October, 20222, one needs to carefully plan their savings to outpace inflation. You may prefer to keep minimum funds in your savings account and park the rest in better alternatives like a sweep-in fixed deposit or a liquid mutual fund that may help in earning better returns.
Every investment opportunity that you forgo by leaving your money idle in the savings bank account comes at a cost called opportunity cost. Let’s know more about the concept of opportunity cost and understand the solution.
The Concept of Opportunity Cost
The opportunity cost in an investment is the potential forgone return or gain due to a missed investment opportunity. When you choose one investment option over the other, the potential return that you may make from the alternative investment is foregone. Basically, the opportunity cost concept can be used to analyse and compare all the options available to you before you make a final investment decision.
For example, you have received a bonus of INR 1,00,000, which is an additional saving or corpus that you have parked in your savings account. Let’s say you would not need this money for any of your short-term needs. You could invest in any investment product. Let’s say you choose to invest in the fixed deposit that can fetch you a 6% p.a. interest rate. If the same money is invested in an equity mutual fund, you would have earned a return, say at the compounded annual growth rate of 10% subject to market risk. The difference between these profits estimated would be your opportunity cost for the investment decision that you have made.
The Solution?
Then, what is the solution to put your money to suitable use? You may consider various investment options suitable for your investment goals, risk-taking ability, and time horizon that you have. The preferred way is to follow 50/30/203 budget rule* . From your income, 50% for needs, 30% for wants, and 20% for saving and making debt repayments.
Any surplus income that is more than your month’s expenses, can be invested in other financial products depending on your goals – short-term, medium-term, or long-term. If you plan to keep aside that money as an emergency fund, then you may consider parking it in liquid mutual funds. Let’s say the money is not needed for any short-term requirements. You may consider the following investment options for your medium-term or long-term goals to minimise the opportunity cost:
1. Mutual fund SIPs
To reduce the opportunity cost and to build wealth for your long-term goals like retirement planning, you may choose to invest in equity mutual funds every month through a systematic investment plan route. Mutual fund SIPs are one of the preferred investment avenues for retirement planning that can build a suitable retirement.
2. Bonds
If your risk-taking ability is low to moderate, you may consider investing in bonds for your medium-term and long-term goals. Bonds are debt instruments that have the potential to generate appropriate returns with low to moderate risk.
3. Direct Equity
Equities are considered to be the assets that can generate market linked returns in the long run but with risk associated with it. Equity allocation may be preferred when you start your financial planning and work out an investment mix for your long-term goals.
4. Insurance plan
There are some tailor-made investments or savings cum insurance plans offered by insurance companies that may give you the dual benefit of financial security against uncertainties and also wealth creation for future goals. Life insurance plans that are market-linked, called unit-linked insurance plans, can help you build a market linked corpus for future financial goals that are decades away along with giving you life cover. There are many savings plans that are specially curated for specific goals. Along with all these benefits, life insurance plans are tax-efficient investments, and the benefit can be claimed under Section 80C of the Income Tax Act,1961.
Though keeping money in your savings account has its own benefits, it is important to not keep it idle. Hence, invest your additional income wisely for your future.
Source:
1https://www.paisabazaar.com/savings-account/interest-rates/#:~:text=All%20banks%20set%20interest%20rates,on%20the%20amount%20of%20savings
2https://www.forbes.com/advisor/in/personal-finance/inflation-rate-in-india/
3https://economictimes.indiatimes.com/wealth/plan/what-is-the-50-30-20-rule-in-personal-finance/articleshow/93963498.cms
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