Savings, investment and credit

Savings means keeping part of today's money (or another resource) aside for the future. Savings protect a family against future needs, and help the whole economy: money saved in banks is lent out to start and grow businesses, which is called capital formation.

• A family's saving depends on its ability to save (mostly income: a low-income family may have little left after basic needs) and its willingness to save (its long-term goals, and readiness to give up some luxuries now).
• Saving takes discipline, planning, co-operation and hard work. Saving just for its own sake is pointless: it has meaning when the purpose is clear to every member and the money is wisely invested.

Investment means putting savings to productive use. Cash hidden in a cupboard or a tin box is saved but not invested.

• Financial assets: bank and post office deposits, credit societies, shares, securities, insurance, provident funds. These give financial security and are productive in economic terms.
• Physical assets: land, a house, gold, durable household goods. The book says these are not productive in the economic sense (they do not lead to capital formation), but they usually give long-term returns.

Principles of sound investment:

• Safety of the principal (the amount invested) comes first. Spread the risk: government and private schemes (NSC, PPF, Kisan Vikas Patra, fixed deposits), different companies and regions, different kinds of assets; check the reputation of whoever issues them; understand the stage of the business cycle.
• Reasonable return: the higher the return, the higher the risk. People living on their investments may prefer a steady return to a higher, uncertain one.
• Liquidity: how easily the investment turns into cash without losing value. The more liquid, the lower the return, so balance the two.
• World conditions: business trends at home and abroad affect investments.
• Accessibility and convenience: invest only in what you understand and can manage.
• Maturity matched to needs: time investments to mature when money will be needed, such as for a child's higher education.
• Tax efficiency: some investments (insurance, Employees' Provident Fund, PPF) carry tax rebates up to a limit.
• After-investment service: easy encashment, timely interest and repayment, and clear information on changes.
• Time period (lock-in): longer deposits usually earn more interest but tie up money longer.
• Capacity: never invest beyond what the family can afford; balance present and future needs.

Avenues open to Indian families: post office, banks, Unit Trust of India, National Savings Scheme and Certificates, shares and debentures, bonds, mutual funds, provident fund, PPF, chit funds, life and medical insurance, pension schemes, and gold, house and land.

Credit comes from the Latin 'credo', 'I believe'. It means getting money, goods or services now and paying later, usually with interest, sometimes at a high rate. Credit increases buying power for a time, but the loan and its interest must be repaid. Families borrow for costly things they cannot save for in time (like land), for emergencies like illness, and for obligations like weddings or funeral rites.

The 4 Cs of credit decide whether a lender trusts a borrower:

• Character: the willingness and determination to repay as agreed, even when it becomes harder than expected.
• Capacity: the ability to repay on time. It depends not on total income but on the margin left after necessary expenses.
• Capital: net worth, what the family owns minus what it owes. It gives the lender a margin of safety.
• Collateral: specific property pledged as security for a loan, which the lender may sell if the loan is not repaid.

Sources of credit: commercial, co-operative and agricultural banks, credit unions, and self-help groups. In a self-help group, members put in a little money every month to build a common fund, and lend to a member in need; because members know each other, no collateral is needed and interest is low.

Use credit wisely. Before borrowing, think not only of the pleasure of owning the item but of how repayments will squeeze future budgets. Used carelessly, credit can be disastrous. Most families should first try to avoid credit, and when they must borrow, borrow at the lowest possible cost.

Example (new): Ravi earns Rs 18,000 a month and his family's necessary spending is Rs 15,500. His capacity to repay is the Rs 2,500 margin, not the Rs 18,000, so a loan needing Rs 4,000 a month is beyond him.