A decade ago, the seminal blog post “Fund Volatility and SIP Returns” shattered a cornerstone of mutual fund marketing by demonstrating—through three distinct three-year analyses—that choosing more volatile equity funds does not guarantee superior SIP outcomes and can inflict severe losses when redemptions occur during market downturns. It warned that pursuing such a strategy can lead to disastrous consequences if investors are forced to redeem in a bear phase. This evidence-based critique, widely cited by advisors and analysts, questioned the very premise of volatility-driven SIP strategies and laid the groundwork for a more disciplined, data-driven approach to systematic investing.

Read the full 2015 article here: https://mfpositive.blogspot.com/2015/06/fund-volatility-and-sip-returns.html

1. The Decade of Exponential Growth in India’s SIP Market

Since 2015, SIP AUM has exploded from under ₹2 lakh crore to over ₹8 lakh crore in 2025, fueled by:

• Digital Transformation: Fintech apps now account for 75% of new SIP registrations, slashing onboarding times.

• Regulatory Reforms: SEBI’s sachet-SIP mandate (₹250 minimum) added 12 million fresh SIP accounts between 2020–25.

• Retail Participation Surge: Active SIPs rose from 8 million to 27 million, reflecting rising incomes and financial literacy.

With monthly SIP inflows surpassing ₹1.2 lakh crore in FY 2025, fund managers, CFPs, and wealth advisors confront unprecedented flows and must revisit foundational assumptions.

2. Building the Premise: Why Volatility Narratives Persist

Despite consistent long-term equity gains, volatility remains a marketing and advisory focal point:

• High-Volatility Tags: 60% of fund houses label funds by volatility tiers to attract yield-seeking SIP investors.

• Industry Buzz: “Volatility arbitrage” and “timing the dip” dominate 80% of webinars, promising 3–5% short-term uplifts.

• Investor Perceptions: 45% of SIP investors equate larger NAV swings with superior return potential.

The pivotal question endures:

Over multi-year horizons, does pursuing volatile funds truly enhance cumulative SIP returns—and at what risk?

3. Empirical Validation: Short-Term Divergence, Long-Term Convergence

A 22-year analysis of monthly Nifty 50 SIPs confirms:

• 1–3 Year Windows: Volatility timing can add 0.5–2.5% p.a.

• 7–10 Year Horizons: Gains shrink below 0.1%, becoming statistically and economically trivial.¹²

• Cross-Fund Convergence: SIP XIRRs across 50 large- and mid-cap funds converge within ±0.2% of index returns regardless of relative volatility.³

These findings echo the 2015 article’s core insight: time in market outweighs volatility-based fund selection.

4. Behavioral Finance: The True Return Driver

Modern research reveals that investor behavior, not fund volatility, dictates real-world SIP outcomes:

• Loss Aversion: 38% of SIPs are halted after one down quarter, negating average 3.1% p.a. gains.⁴

• Herding: 27% of new SIPs chase recent top performers, leading to momentum mistakes.⁴

• Disposition Effect: Holding losses 45% longer than winners costs ~0.7% p.a…⁴

Advisory focus must shift to mitigating behavioral biases and preventing forced redemptions at market troughs.

5. Portfolio-Size Dynamics: When Rupee Cost Averaging Diminishes

Rupee cost averaging benefits wane as corpus grows:

• Under ₹10 lakh: SIP XIRR outperforms lump-sum by ~0.8% in volatile phases.

• Above ₹50–75 lakh: New installments represent <5% of corpus; XIRR edge falls under 0.1%.⁵

For ultra-HNWIs (e.g., ₹2 crore portfolios), the marginal advantage of tranche timing or volatility chasing is effectively negligible, often under 0.05% p.a.

6. Debunking Rupee Cost Averaging Myths and Tax Realities

Return Parity

SIP vs. lump-sum in Nifty 50 over 5+ years: 6.65% vs. 6.68% p.a. (0.03% difference).⁶

Expense Impact

Passive index ETFs (0.05–0.15% p.a.) vastly outperform high-cost active funds (1.0–1.8% p.a.) on net SIP returns, dwarfing any volatility timing effects.

Tax Efficiency

Under current rules, equity SIPs held over one year incur long-term capital gains tax at 12.5% on gains exceeding ₹1.25 lakh per financial year. While tranche-based exits can boost after-tax XIRR by 0.3–0.5% for smaller portfolios, for a ₹2 crore corpus the benefit is under 0.05%—rendering tax timing a secondary consideration for larger investments.

7. Active vs. Passive: Evidence from the Indian Market

Broad-based passive funds consistently match or exceed net returns of large-cap active funds due to significantly lower expense ratios. In 2025, active managers’ one-year success rate across 38 equity categories stood at just 29%, nearly unchanged from 2024.⁷

Sectoral and mid-cap active funds occasionally generate genuine alpha, but higher fees and turnover often erode these gains—underscoring the “cruel math” of low active share and high expense drag.

8. Expanded 2025 Considerations

• ESG & Thematic SIPs: Higher initial volatility but converge within ±0.3% of core benchmarks over 7–10 years.

• Technology & Robo-Advisory: Automated SIP escalations, rebalancing, and behavioral nudges enforce discipline without volatility chasing.

• Stress-Testing: In extreme market stress, uninterrupted SIPs outperform timing strategies by 1.2–1.8% during recovery phases.

9. Actionable Framework for Advisors

1. Champion Discipline: Emphasize time-in-market over volatility timing.

2. Calibrate Expectations: Use realistic CAGR forecasts, not 12–15%. Exphasise that investors’ behaviour and tenure has a bigger role to play.

3. Mitigate Biases: Embed automated behavioral nudges and alerts to prevent forced redemptions.

4. Rebalance Smartly: Transition from cost averaging to strategic asset allocation as portfolios mature.

5. Optimize Costs: Prioritize low-expense funds with established alpha.

6. Leverage Tax Rules: For smaller portfolios, tranche exits can marginally improve after-tax XIRR; for larger portfolios, focus on allocation and cost efficiency.

7. Integrate Thematics: Allocate ESG and thematic exposures within a diversified core.

8. Harness Technology: Deploy robo-advisory solutions for disciplined SIP execution and rebalancing.

10. Conclusion

Ten years on, the 2015 critique—that there is no volatility advantage in SIP investing and that forced redemptions in bear phases can be disastrous—has been unequivocally validated by extensive market data, behavioral research, expense and tax analyses, and passive vs. active performance evidence. In an era of massive SIP inflows and sophisticated investor expectations, discipline, realistic goal-setting, cost and tax efficiency, and behavioral management are the true pillars of sustainable SIP success. Senior advisors and fund managers must realign strategies to these enduring principles, leaving volatility myths firmly in the past.

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1. https://arxiv.org/html/2507.04859v1 ↩︎

2. https://economictimes.com/mf/analysis/market-timing-has-little-impact-on-sip-returns-motilal-oswal-mf-study/articleshow/122985351.cms ↩︎

3. https://www.advisorkhoj.com/mutual-funds-research/top-performing-systematic-investment-plan ↩︎

4. https://ijirt.org/publishedpaper/IJIRT174912_PAPER.pdf ↩︎ ↩︎ ↩︎

5. https://economictimes.com/markets/stocks/news/does-rupee-cost-averaging-really-work-for-sip-beyond-a-point-rethink-your-strategy/articleshow/102237286.cms ↩︎

6. https://freefincal.com/rupee-cost-averaging-via-sip-has-no-benefit-other-than-accumulating-mf-units/ ↩︎

7. https://www.morningstar.com/business/insights/blog/funds/active-vs-passive-investing ↩︎

8. https://arxiv.org/html/2507.04859v2 ↩︎

CAGR is a useful tool for evaluating the performance of mutual funds over time. It provides a standardized way to compare the returns of different funds, even if they have different investment horizons.

Here is the formula for calculating CAGR:

CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) - 1

Where:

• Ending Value is the value of the investment at the end of the period.

• Beginning Value is the value of the investment at the beginning of the period.

• Number of Years is the length of the period in years.

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  CAGR in Mutual Funds

  In the context of mutual funds, CAGR is a crucial tool for assessing the performance of a fund over time. It provides a standardized way to compare the returns of different funds, even if they have experienced varying levels of volatility.  

  Calculating CAGR: An Example

  Scenario: You invested in a mutual fund 8 years ago. The NAV (Net Asset Value) at the time of investment was ₹100. Today, the NAV is ₹250. You want to calculate the CAGR.

  Formula:

  CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) - 1
  

  Calculation:

  CAGR = (250 / 100)^(1 / 8) - 1
       = 2.5^(1/8) - 1
       ≈ 1.158 - 1
       ≈ 0.158
  

  Converting to percentage:

  CAGR = 0.158 * 100 = 15.8%
  

  Interpretation: This means that your investment has grown at an average annual rate of 15.8% over the past 8 years, considering the effects of compounding.

  Key points to remember:

  • CAGR provides a smoothed-out view of the investment's performance, accounting for fluctuations.  

  • It's a useful tool for comparing different investment options.

  • A higher CAGR generally indicates better performance.

  By understanding CAGR, you can make more informed decisions about your mutual fund investments and track their long-term growth.

Drawbacks of CAGR

While CAGR is a valuable tool for evaluating investment performance, it has some limitations:

1. Doesn't Account for Volatility: CAGR provides a smoothed-out average return, ignoring the ups and downs of an investment's performance. This can mask significant risks or volatility.

2. Assumes Constant Returns: CAGR assumes that the growth rate is constant throughout the investment period. In reality, returns can fluctuate significantly, making the CAGR less accurate.

3. Ignores the Time Value of Money: CAGR doesn't consider the time value of money, which means that returns earned earlier are worth more than returns earned later due to the potential for compounding.

4. Can Be Misleading in Certain Scenarios: CAGR can be misleading when comparing investments with different risk profiles. For example, a high-risk investment with a high CAGR may not be suitable for risk-averse investors.

5. Doesn't Consider Reinvestment: CAGR assumes that all returns are reinvested, which may not always be the case. If dividends or capital gains are withdrawn, the actual return may be lower.

To overcome these limitations, investors should consider using additional metrics, such as standard deviation, Sharpe ratio, and Sortino ratio, to get a more comprehensive picture of an investment's performance.

What Are Rolling Returns?

Rolling returns are calculated by taking the annualized average returns for a given period, such as 1, 3, or 5 years, and then moving the starting point forward one period at a time. This process is repeated continuously, providing a series of returns for each overlapping period.

Why Use Rolling Returns?

Rolling returns are useful for examining the behavior of returns over different holding periods, similar to those actually experienced by investors4. They help smooth out the performance data over several periods, providing a more comprehensive view of an investment's performance over time.

Rolling Returns of Mutual Funds: A 7-Year Example

As explained earlier, Rolling returns is a method of calculating the return of an investment over a specific period, in this case, 7 years, by using overlapping periods. This approach helps to smooth out the volatility and provides a more comprehensive picture of the fund's performance.

Let's consider an example:

Suppose we have a mutual fund with daily NAV (Net Asset Value) data for the last 15 years, from August 21, 2009, to August 21, 2024.

Calculating 7-Year Rolling Returns:

To calculate the 7-year rolling returns, we will use the following steps:

1. Start from the first 7-year period: August 21, 2009, to August 21, 2016.

2. Calculate the return for this period using the formula: (Ending NAV / Beginning NAV) - 1

3. Move to the next 7-year period: August 22, 2009, to August 22, 2016.

4. Calculate the return for this period using the same formula.

5. Repeat steps 3-4 for each day, moving the 7-year window one day at a time, until we reach the last 7-year period: August 15, 2017, to August 21, 2024.

Example Rolling Returns Data:

Summarizing Rolling Returns:

To summarize the various rolling returns, we can use the following methods:

1. Return Bracket Analysis

2. Best and Worst Performance Matrix

3. Quartile Analysis

Quartile Value

25th Percentile 9.5%

50th Percentile 12.1%

75th Percentile 14.8%

4. Cumulative Distribution Function (CDF)

The CDF shows the percentage of rolling returns that fall below a certain value.

Return CDF

5% 10%

10% 30%

15% 60%

20% 80%

5. Average Rolling Returns by Year

Year Average 7-Year Return

2010 8.5%

2011 9.2%......

2023 13.1%

These methods provide a comprehensive picture of the fund's rolling returns, helping us understand its performance, risk, and potential.

Profit is almost always the benchmark for risk since we invest to make a profit. The majority of people define an investment's risk as the potential loss of capital as well as the likelihood that it will do so. Others may view risk in a broader sense and not necessarily in the form of a loss rather than a gain - as the possibility of making a mistake that may take them away from their intended objective

Most of the time, your investments are tied to a financial goal, also known as a goal-based portfolio, and you may discover that the only way to reduce the risk of not achieving your goal is to increase the risk of your portfolio. Investing entirely in fixed deposits, for example, may reduce your investment risk but significantly reduces your likelihood of achieving a decent retirement corpus.

In such a case, as an investor, will you prioritise the risk of your portfolio or the risk of failing to meet your objectives?

Debt funds carry a lesser short-term risk of losing money compared to equity funds but carry a much higher risk of underperforming. Over the period of over ten years, someone who invests only in equity funds will likely accumulate more money than those who invest only in debt funds. Having a thorough understanding of risk can help us make better investment decisions.

We could define risk in a variety of ways, but the fact remains that risk assessment is highly subjective. Something risky to one person may not be risky, or equally risky, to another. Risk toleration1 is the result of a combination of risk preference and risk perception2.

Then, what is the reality of investment risk?

Making judgments about your financial holdings necessitates making choices. Risk can be described as any uncertainty regarding choices and decisions that has the potential to adversely affect your financial well-being.

The negative consequences of several of these options are apparent. For example, if you buy a store or a property to generate monthly cash flow, there is no certainty that you will receive the expected rent. Another uncertainty is finding a tenant right away. These uncertainties have the potential to affect your financial well-being.

While these are basic examples, not all investment options may have similar immediately identifiable risks.

Uncertainty is everywhere

First, you choose a fixed deposit because it is the simplest and safest type of investment.

However, you soon realized that the revenue from fixed deposits was insufficient, so you began lending money to firms by acquiring bonds issued by them.

You later realized that these financial firms could go bankrupt, leaving you with uncertainty about receiving your money back.

So you began investing in multiple corporate bonds to mitigate the risk posed by the uncertainty of principal return. Meanwhile, interest in the market increased, and you realized that your bonds were earning a lower rate of interest than the market rates, causing market prices to plummet. You discovered that as interest rates fluctuate, there is always the uncertainty that you would be unable to sell the bonds at a price higher than what you paid for them.

However, after discovering that the prices of shorter-term bonds were less affected by changes in market interest rates, you began purchasing bonds with varying maturities to spread the uncertainty associated with price changes caused by changes in interest rates.

Interest rates continued to rise, as they do in any developing economy, forcing even shorter-term bonds to lose value. You shifted your investments to floating rate bonds to safeguard yourself. Some of you even went to cash.

Soon after, interest rates stabilized, and you assumed your debt investments were safe, only to discover that inflation and taxes were eating away at the value of your money and that the safety of money does not provide the certainty that money shall preserve its value.

You were informed that equity shares are preferable investments since they can offer positive returns after adjusting for inflation and taxes. As a result, you switched a portion of your portfolio to equity investment. The next day, you noticed that the value of your equity investment had declined by 3%. You discovered that the market value of any equity investment fluctuates and that there is no certainty that you will be able to sell them at a better price than you paid for them in the near term, or even in the long run. Even worse was the realization when you notice that while equity markets, in general, are rising the value of your equity investment is not.

You diversified into an equity portfolio to lessen the impact of this uncertainty. However, you quickly realized that the majority of the stocks in your portfolio belonged to a single, underperforming sector. This alerted you to another uncertainty - the fact that not all business segments will rise in a rising market.

The preceding paragraph seeks to provide insight into the complex nature of uncertainty surrounding our investing decisions. The risks surrounding various investment products may be numerous. Still, one thing is certain: we require assistance to learn about them and determine whether these uncertainties are within our tolerance limits.

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Recommended reading for geeks

1. Risk interpretation and action (While this is about natural hazards, if you skip the first two sections, you'll find some wonderful paragraphs about various aspects of risk.)

It explains how to compute future and present values using compounding and discounting, and why one rupee today is worth more than one rupee a year from now.

After reading this primer, you should be able to:

• Determine the future value of the current amount of money.

• Determine the present value of a series of payments made at regular intervals (annuity).

• Determine the present value of a future sum of money.

• Determine the annuity's present value.

Example

You have met your sales goals. When your company announces a bonus for you, you have two options:

1. Take Rs. 1 lac in 6 months,

2. or Rs. 55000 6 months from now, followed by another Rs. 55000 after a year.

Which one will you pick?

The answer is difficult. Why? It's difficult for us because we have to choose between money at various points in time. The concept of money's time value helps us solve problems like these.

Let us start with a relatively simple example. Your boss wishes to present you with a gift, ah I wish bosses were that generous. Which of the following alternatives do you prefer? Getting

1. Rs. 1 lac today

2. Rs. 1 lac in a year

The fact that you prefer one of them implies that the amounts are not equal. And the fact that you chose option 1 indicates that you value it more than option 2. One lac received today will generate more money (interest) over the next year, making it more valuable than one lac received after one year.

This is known as the time value of money. It refers to the fundamental principle that money can earn interest over time; as a result, something received today is worth more than something received tomorrow.

The future worth of a current sum of money.

Compounding annually

You received a one-lakh-rupee bonus. You deposited it with the bank for 2 years at a rate of 10% compounding per year. Determine the amount you will receive upon maturity.

The following formula can be used to solve the following problem:

FV = PV x (1+r)^n

Where, 

FV is an abbreviation for Future Value. 

PV is an abbreviation for Present Value. 

r = annual interest rate 

n = the number of years

Applying the formula,

FV = PV x (1+r)^n

FV = 100000 x (1+10/100)^2

FV = 100000 x (1.1)^2

FV = 100000 x 1.21

FV = 121000

Aside from annual compounding

You received a one-lakh-rupee bonus. You deposited it with the bank for 2 years at a rate of 10% compounding per 6 months. Determine the amount you will receive upon maturity.

It is important to note that if r (interest rate) is per annum, then n (number of periods) must be in years. If r (interest rate) is half-yearly, then n (number of periods) must be a total of 6 months. Similar adjustments must be made in the case of quarterly compounding. In such cases, the formula is

FV = PV x (1+r/m)^(nxm)

Where, 

FV is an abbreviation for Future Value. 

PV is an abbreviation for Present Value. 

r = annual interest rate 

n = the number of years

m = number of periods in a year

Applying the formula,

FV = PV x (1+r/m)^(nxm)

FV = 100000 x (1+10%/2)^(2X2)

FV = 100000 x (1.05)^4

FV = 100000 x 1.2155

FV = 121550

Note: The future value in the first example was 1,21,000, whereas the future value in the second example was Rs.550 higher. This occurred because, in the second example, compounding occurred after every six months, thereby adding more income.

A quick method - Rule of 72

Mr Sharma has invested Rs. 50000 at an interest rate of 8%. He wants to know how long it will take for his money to double.

As a rule of thumb, the formula below will help you with quick calculations.

• The doubling time = 72/ interest rate. ( Just take the number without the %)

• The interest rate = 72/doubling time.

Applying the same, Mr Sharma's money will be doubled in 72/8 = 9 years.

Please keep in mind that this is just a rule of thumb to get approximate answers. The actual answers vary.

Here's a quick self-evaluation question for you.

Ms Sharma requires your assistance. She has invested Rs. 5000 in a 12% fixed deposit to purchase a washing machine in the future. How many years will she be able to buy a washing machine if the price remains at Rs. 10,000?

Future value of a series of payments at regular intervals (annuity)

How would we compute the present value if a series of payments occurred at regular intervals in the future?

At the end of each period, investments are made.

Mr Sharma intends to invest Rs. 70000 each year for the next 15 years. How much money would he have at the end of the fifteenth year? Assume an annual interest rate of 8%.

The following formula can be used to solve the following problem:

FV = A x [{(1+r)^n}-1]/r

Where, 

FV is an abbreviation for Future value of the annuity at time n 

A is an abbreviation for the Value of individual payment in each compounded period

r = rate of interest compounded for each period

n = the number of periods

Using the above formula, the calculation yields the result 1900648.

Investments are made at the start of each period

What is the final amount in the previous example if Mr Sharma invests at the start of each year?

The following formula can be used to solve the following problem:

FV = A x [{(1+r)^(n+1)}-(1+r)]/r

Where, 

FV is an abbreviation for Future value of the annuity at time n 

A is an abbreviation for the Value of individual payment in each compounded period

r = rate of interest compounded for each period

n = the number of periods

Using the above formula, the calculation yields the result 2052700.

Discounting

Determining the present value of a future sum

Mr. Sharma's son has been accepted into the Engineering programme. Mr. Sharma wishes to give his son Rs 2 lakh upon successful completion of the course after four years. How much should he invest now in order to have Rs. 2 Lac in four years if his investment grows at a rate of 12% per year?

This is, as you can see, the inverse of what we did in compunding.

PV = FV / (1+r)^n

Where, 

FV is an abbreviation for Future Value. 

PV is an abbreviation for Present Value. 

r = annual interest rate 

n = the number of years

Applying the formula,

PV = FV / (1+r)^n

PV = 200000 / (1+12/100)^4

PV = 200000 / (1.12)^4

PV = 200000 / 1.5735

PV = 127104

1. Maintain consistency in what you're aiming to accomplish.

2. Beginning slowly enables your mind and body to not respond to the changes you're trying to make as harshly. And it makes achieving it simpler.

3. Your biggest obstacle is that saving is a very dull activity with no glitz and glamour. Just because it seems like there should be more flashing lights doesn't mean you should give up.

Follow through these consistently and see where it leads.

Are there any specific spending habits or expenses that I need to watch out for?

Online shopping

The greatest advantage of online shopping for any consumer is also the greatest drawback for a careless one: this market never closes. When an urge strikes, an individual can buy anything, regardless of time or place. People are finding it much simpler to spend money and much more difficult to save money because of this. A study1 of around 1000 customers conducted over two months in 2016 found that, while people knew how much time they spent on online purchases, they grossly underestimated how much money they spent.

Businesses are profit-driven enterprises that are always devising new methods to separate customers from their money. Making online shopping enjoyable is one such method. Companies are leveraging expertise in mobile technology, online advertising, and the credit card industry to make shopping even more addicting. Their focus is understandable given that internet companies gather and sell data, offering statistical information about consumers' online buying behaviour in many nations2. These studies provide data on conversion rates, average order value, and the influence of social media and mobile devices in online retail shopping.

Shopping on EMI

Individuals all over the world are getting accustomed to spending money they have not yet earned. This is due to a phenomenon known as CREDIT.

Most people use credit in a variety of ways. The most common example is credit cards. Another common example of credit is purchasing something in instalments. In the market, this is referred to as an EMI purchase, which stands for equated monthly payments. When a consumer purchases something on EMI, he is given the option of paying the entire amount in one lump sum or predetermined monthly payments in the future. In essence, this service delays payment by a few months while enhancing the consumer's spending power. However, this option has the unfortunate consequence of causing users to overspend. They end up buying something far more expensive than they could afford based on their existing wages, or they overspend on stuff they don't need. Successful investors who have attained financial independence will tell you that distinguishing between necessities and desires is critical to their success. Many will also argue that achieving a balance between desires and requirements is half the battle in any savings plan. It is commonplace for many customers to spend significantly more than they would have if credit had not been available to them. This occurs because their desire takes flight, due to the EMI facility.

While there are many different types of EMI, the most appealing to consumers is "no-cost EMI." The consumer is not charged interest in this type of EMI. In essence, investors pay the product's actual cost in EMIs. Many experts feel that a no-cost EMI is a mutually beneficial arrangement between a product seller, a financing bank or company, and the customer. The customer acquires high-priced goods and joyfully pays for them in monthly instalments, acknowledging that he is doing so without incurring any interest costs. The finance company not only earns a percentage of the seller's margin but also gains an extra client to market its other products, and the seller, who shares a portion of its margins with the financing company, gains access to a specific market for a category of its products.

An EMI of this type provides customers with the impression that they have not been charged for the credit provided by the vendor or credit card issuer. However, consumers should keep in mind that "nothing comes for free." What the Reserve Bank of India has to say about "Zero Percent Interest Finance Schemes for Consumer Durables"3 is crucial.

“Banks should refrain from offering low / zero per cent interest rates on consumer durable advances to borrowers through adjustment of discount available from manufacturers/dealers of consumer goods since such loan schemes lack transparency in operations and distort pricing mechanism of loan products. These products do not also give a clear picture to the customers regarding the applicable interest rates. Banks should, also, not promote such schemes by releasing advertisements in different newspapers and media indicating that they are promoting / financing consumers under such schemes. They should also refrain from linking their names in any form/manner with any incentive-based advertisement where clarity regarding interest rate is absent.”

Have you ever wondered how you select appropriate financial instruments if you didn't know what you want from your investments? Simply put, you need to know your investment objectives.

Investment objectives, in a nutshell, are your reasons for investing, and they determine the types of assets you add to your portfolio.

The investment instruments that you include in your portfolio are determined by the goals for which you intend to invest your money. Knowing what you want investments to do for you would help you decide which types of investments are best for you.

Although it's possible that choosing financial instruments for your portfolio won't be solely based on your investing goals. Your concerns, notably your investment horizon and risk tolerance, will also play a role in the decision-making process.

Assume yourself to be a financial advisor to better understand the concepts. An investor has invited you for investment guidance. What would be your first question?

"What do you expect to gain from this investment?" you'll ask.

"Double my money in five years," he declares.

“What for?” you ask.

“To purchase a farmhouse,” he tells you.

That indicates that his primary goal is growth. He intends to invest this money for a long period without expecting any income in the interim. On the other hand, you may have come across an investor whose main goal in investing is to generate a consistent income that will allow him to pay his bills.

You offer him a plan that invests in shares since you realise he would need higher returns for his objective.

He responds negatively and says, "I've heard that people could lose money in shares. I don't want to incur a financial loss.”

You understand that his concern is safety or not putting his money at risk. You inform him that to get returns of 12–15% annually in the current market, he must assume a significant risk. It may take you a while, or you may never be able, to convince him that an investor must take risks to receive higher returns. Even though this investor's main goal is capital growth, his risk aversion may prevent him, and rightly so, from making investments in stocks.

The simple conversation will show me how an investor's expectations influence the selection of an appropriate investment product. Most investors, as a matter of fact, need to be educated in terms of shaping their investment expectations in order to modify their attitude toward risk or better understand risk, not only to have a smooth investment experience but also to achieve their financial objectives.

Give me some examples of investment objectives that I can relate to?

You could have three types of objectives - growth, income, or both growth and income.

GROWTH

Your objective is growth if you want to invest and let your money grow over a long period without taking any income or principal out of it.

You may want to consider the following two important questions to determine your investment goal. Do you intend to use the money for a goal that is at least 10 years away? Are you willing to take risks when you invest, specifically the risk of a reduction in the value of your investment?

INCOME

Some investors may need recurring income from their investments to meet their cash flow needs. There are several potential causes for this.

A retiree, for instance, could need a monthly income from his investments to cover his living expenses. To keep the risk in check, an investor with a moderate appetite for risk may want to continue getting cash flows from his investments regularly. Or, as part of a larger risk-reduction plan, an investor may desire to diversify his holdings by including income-producing investments.

INCOME AND GROWTH

Certain types of investors might desire both long-term capital growth and a steady stream of income.

An investor who relies on his portfolio to provide consistent income may need to outperform inflation each year for the foreseeable future. He would require building a portfolio that produces regular income as well as grows so that the capital always remains sufficient to produce income that is higher than inflation.

SAFETY OF CAPITAL

An investor can occasionally desire to buy securities that will protect his capital. For instance, retired or unemployed individuals may prefer to invest their savings to earn income for themselves without taking any risks with the assets. Or an individual who has money set aside for a down payment on a house soon could prefer to invest for a very little time without taking any risks.

How can I determine my investment objectives?

Begin by asking some important questions. These will assist you in identifying your requirements and constraints.

1. What financial goal do you want to accomplish with the investment? This helps you identify your financial objective.

2. How soon will you require this money, exactly? You can determine your investment tenure using the response.

3. Which of the following best describes your approach to investing in general: are you a risk-averse, moderate-risk taker, or risk-loving investor?

4. What is your main worry with this specific investment's value—do you want to preserve it at its current value or are you willing to endure the ups and downs in its value to ensure it grows?

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An equity instrument grants ownership rights in a business, but a debt instrument indicates that we have loaned money to a person, government, or business.

Debt

Simply defined, debt indicates that the issuer of the instrument borrowed money. The following conditions must be met for a transaction to be termed lending or borrowing. The first is a promise to repay. The second is the amount of compensation termed “interest”, which is paid for the use of the borrowed money. The next is the date when the monies will be refunded, known as the maturity. Most investors perceive debt as less risky due to the contractual specificity, as there is a commitment to pay interest regularly and return the money at maturity, indicating that the investor will earn money regularly and receive the investment back at maturity.

Deposits are used by banks and financial institutions to borrow money. As an investor (also known as a depositor), you can choose the duration for which you want to give money to the bank in exchange for an interest rate. They provide a variety of interest payment options, including monthly, quarterly, annual, and at maturity. You can choose one of these based on your cash flow requirement. When the deposit matures, you can opt to receive it back or roll it over for a longer period.

The Indian government borrows via government securities. The government offers these securities in exchange for varying maturities of borrowings. Short-term borrowings of less than one year are known as treasury bills, whereas long-term borrowings (up to 40 years) are known as bonds. While the majority of the borrowings have a set rate of interest paid semi-annually, the GoI also issues variable rate bonds with interest rates that fluctuate in line with the benchmark. The money is only repaid by the government when the security reaches maturity. In the meantime, the securities can be sold on the secondary market by investors. As many market participants are statutorily obligated to participate in government assets, the secondary markets for these securities are particularly liquid. Furthermore, due to the low credit risk, securities are one of the most popular investment instruments.

Cooperates borrow money through the issuance of nonconvertible debentures (NCD). These securities pay interest, a coupon, which is either paid annually or semi-annually. In general, the securities are issued for no more than ten years. While the borrowing entity is required to repay the funds at maturity, investors can sell the securities on any of the markets where they are listed. Despite the listing, the securities are not extremely liquid as very few people, particularly almost negligible retail investors, trade in them.

You can see from the preceding paragraphs that debt securities are essentially transactions like borrowing and lending. While some may argue that this is a fairly simplistic description of debt securities, it does assist in properly understanding the features, including the return and risk, of these instruments.

We have a separate segment on debt instruments and markets. You should subscribe if you want to receive regular posts directly in your email.

What is Equity?

Equity, on the other hand, confer ownership rights. The most common type of equity instrument is a "share" that is issued by a company1. A "share" means a share in the share capital of a company2. A shareholder is a person who holds a share. The owner is entitled to a share of a company's profits and must share losses. Unlike debt, a share neither has a provision of paying any compensation, interest3 or otherwise, periodically nor does it have a maturity date. The business of a company is run by a board of directors and if they decide the profits are distributed to the shareholders, called dividends.

From where can I buy shares?

From the company during an Initial Public Offer of shares by the company

You can apply to buy shares in a company during its initial public offering (IPO). This is the first time a company sells its shares to the general public for investment. During an IPO, the company prices its shares in consultation with its issue managers. If the price is appealing and the company has promising prospects, the IPO is frequently oversubscribed, resulting in very little or no allocation to the general public.

A company issues shares to investors in an IPO for three reasons: First, some existing shareholders will be given an exit option. Existing shareholders reduce or eliminate their ownership by selling a portion of their shares to investors. In this case, the shares simply change hands from one set of owners to the other; no new equity is issued, and the company receives no capital. Second, raising additional capital for a new project or to repay a loan, lowering the company's working capital, or a combination of these. The company raises its capital by issuing new shares that will be used by the company.

From the stock exchanges where the shares are listed - the secondary market

To facilitate trading, every company that issues shares to the public is required to list its shares on the stock exchange. Most companies' shares are traded on the top two Indian stock exchanges, the Bombay Stock Exchange and the National Stock Exchange. These shares are available for purchase on stock exchanges.

Where can I sell these shares?

If an investor decides he no longer wants to hold the share, he can sell it to someone else on any of the stock exchanges. Shares of "listed public companies"4 are pretty liquid, especially the larger ones with good track records.

What is a dividend?

A company's operation is governed by a board of directors, and profits are distributed to shareholders, in the form of dividends, if they so choose. A growing business usually ploughs back the earnings to expand its activities. The shareholder benefits whether or not profit is distributed. He receives a payment if the profits are distributed. Otherwise, the book value and, most likely, the market value of the share increases.

Thus, in the case of equity, both the certainty to earn regularly and the contractual surety to receive the amount on maturity are lacking, whereas they are contractually committed in the case of debt.

Assume Robin has Rs. 10,000 to invest. He invests this money himself "directly" by selecting his investment instruments. So, out of Rs 10,000, he puts Rs 2000 in a fixed deposit, Rs 5000 in shares of Reliance Industries, and Rs 3000 in Government of India bonds. He makes his own investing decision. As a result, we say he is investing his money directly.

Nehal too has Rs. 10,000 to invest. She, on the other hand, is not investing herself. Rather, she has handed it to Karan to invest for her. Karan, not Nehal, would now select the financial products in which Nehal's money is invested. This implies Karan is indirectly investing her money.

Can you think of any reasons why individuals invest "indirectly"? Alternatively, why is Nehal making this investment? The explanation is straightforward. Nehal is indirectly investing her money because she either lacks the requisite investing expertise or does not have the time to invest, especially if she desires to have a well-diversified portfolio. Diversification requires investing in uncorrelated assets, and investing in numerous assets necessitates multiple sets of expertise, additional hours of research, and increased market tracking. It is unquestionably more work for an investor. People invest their money indirectly and seek the advice of a professional primarily for these two reasons.

Other reasons include access to a broader range of investment options, tax advantages, the ability to quickly and easily create a diverse portfolio, and the possibility of higher returns.

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Personal (individual) versus collective investment

That is another way to describe the investing process.

Remember Robin, the man who invested Rs. 2000 in a fixed deposit, Rs. 5000 in Reliance Industries shares, and Rs. 3000 in government bonds?

His investments are commonly known as his "portfolio." He has a separate portfolio for his investments. This also suggests that the profits on his investment will be defined by this portfolio, which he owns alone. This is known as a personal investment.

Robin has another option for investing his Rs. 10000. He establishes a group with his other workplace colleagues (say, 30 pals) and asks each of them to invest Rs. 10,000. This results in a common pool of Rs. 3 lacs. This sum is then invested collectively in a variety of financial instruments. The investment portfolio built in this manner will be tied to the overall group contribution of Rs 3 lakhs, not just Robin's Rs 10,000. Robin and his colleagues will split the profits from this portfolio in proportion to their contributions to the common pool. This is a collective investment method.

Can you think of any reason why people would pool their money? Is there any benefit to investing the money collectively? Is there any disadvantage to individual investing that may be avoided if individuals invest collectively?

So, using Robin as an example, let us try to obtain the answers, for which you must examine the disadvantages or limits for Robin if he chooses to invest Rs. 10,000 on his own.

The magnitude of his capital is the first limitation. He only has Rs. 10,000 to invest, which has the following drawbacks of a limited fund size:

1. It hurts your purchasing power. You will be able to invest only in instruments that are less than Rs. 10,000. If a share of Infosys is offered on the market for Rs. 12000, you will be unable to purchase it. There may be a few solid investment goods, but you would be unable to invest in them because you lack sufficient funds.

2. Simple logic dictates that we should not put all of our money into one venture. You should diversify your investment portfolio. This is known as diversification. If your funds are restricted, you will be unable to diversify your money among several investment options. I'll never forget the first time I travelled to Mumbai for work. My father had handed me 2000 rupees. "Do not keep all the rupees in one pocket," he said. Keep 500 rupees in one, 500 rupees in another, and so forth. That was his method of lowering the chance of theft. Stocks and other forms of investing are no exception. If we put all of our money into a single product, we will lose money on all of our investments if that product fails.

3. Investing continues to be expensive. For example, if an investor wishes to invest Rs. 1 lakh in shares through an advisory brokerage firm, he would have to pay a brokerage of 0.10 per cent to 0.30 per cent on each leg of the transaction because his amount is small. If he invested Rs. 10 crores, his fees might be cut to around 0.01 per cent and much lower for bigger investments. Pooled investments save money due to the economics of large-scale activities.

If you want to achieve financial independence, which we will discuss in our posts starting tomorrow, you must seek guidance.

Most importantly, you must seek financial advice to develop good financial habits. You can learn more about this in this post.

Remember that investing is about more than just money. It is about reducing stress in an environment (the financial markets) that generates a lot of stress.

Those who are sceptical about the value of advisors may want to start by interacting with a few financial advisors. Meet them to learn about their perspectives on wealth and well-being, and to learn how they add value to their investors. Investigate their thoughts on your investment requirements and their offer to you.

Shouldn’t individuals consider investing directly now, when there is ample information available and execution is simple?

The following insights will help you understand the significance of a professional financial advisor.

• There is a vast range of products on the market. Few individuals have the skills or time to evaluate alternatives to determine the greatest fit for their needs or to prioritise the one that is likely to provide the best value for money.

• Furthermore, few people can evaluate financial product providers and compare their potential ability to offer good investment performance. They require the services of an advisor with market experience and a thorough understanding of the products on offer for such an evaluation. After considering the tax treatment of the product and the client's tax status, such an adviser would know which types of products provide the most tax-efficient return for the investor. There is no single product that is tax-efficient for all clients.

• Many financial products are highly complicated and must be explained by a knowledgeable advisor. In addition to the previously accessible simple products such as fixed deposits and PPF, additional products such as pension schemes, alternate investment funds, exchange-traded funds, portfolio management services, fixed maturity plans, target maturity funds, and so on are now available. Market, interest rate, liquidity, and other risks are associated with these new investment products, which investors must thoroughly understand before investing.

Do I still need investing advice if I am affluent or have a high net worth?

Yes. Even wealthy individuals are frequently unaware of the opportunities available. Many of them do not understand why they own a financial instrument and are unsure whether the investment is suitable for their requirements. Employees, for example, may well have accumulated shares via their employers, while high-net-worth individuals may have inherited shares from their parents. Similarly, young people may have assets in the form of public provident funds or fixed deposits in their names, which were mostly contributed by their parents throughout their teenage years. The importance of a skilled financial adviser, as previously indicated, also applies to them. Fortunately, they can afford to pay financial experts to make decisions for them.

You mentioned financial independence; how does it differ from retirement?

You must invest your savings to sustain and increase its worth.

If you understand why you need to save money, you already know the answer to this question. Most people require the assistance of a savings or investment plan to reach their financial goals in life. People who do not have capital must build it by saving from their earnings. People who already have capital must invest it intelligently to preserve and expand its worth.

The next step in both circumstances is to invest funds in ways that will help individuals accomplish their financial goals in the future. This is when an investing strategy comes in handy.

But, I know nothing about investing.

That is not uncommon. The more promising aspect is that you are becoming aware of the importance of financial planning and investing guidance.

People typically do not understand how to identify their savings and investing requirements. This lack of understanding is caused by the following factors:

• Most people are uninformed of the financial planning process.

• People are frequently swayed by their aspirations rather than their true needs.

• Most people, without prompting, prioritise short-term expenditure above long-term financial planning.

• The desire to spend rather than save is compounded by the fact that the immediate appeal of consumer items is more evident and appealing than the intangible benefits of saving that will come sometime later.

I believe I am prepared to save and invest. What comes next?

You should get financial and investing guidance. As previously explained, most people are unable to identify their savings and investment requirements. In truth, many are unaware of the full range of financial instruments available to them. Even when they are aware, they are often unable to match needs with the best type of investment.

Can we use psychology to understand why people don't save?

The inclination to spend money on urgent needs1 and the failure to adopt a committed savings strategy are two variables that contribute to the incapacity to save money.

Every decision not to spend today is a choice between a "want now" and a "need later". Most people who are inclined to save money are frequently faced with the choice of spending money immediately, for immediate gratification of their wishes, vs saving aside money to be invested and utilised for a specific financial need in the future. The immediate pleasure of spending is significantly more appealing to and preferred by the human mind than the more distant reward of saving, such as a comfortable existence after retirement2. As a result, while being aware of, and dedicated to, the need for savings, most people choose instant spending.

Because of the previously indicated change in preference for an immediate outcome, most people begin a savings cycle full of enthusiasm, set budgets, and define the intended savings rate, but the cycle finishes with a substantially lower than the previously expected saving rate. According to studies, the human mind prefers to focus on the large picture when an event is far away and the tiny details when the event is close. People tend to be resolved to save when preparing for savings, say, over the next 1-3 years, since accepting the significance of saving followed by a commitment to save is pleasant to the mind. When the time comes to save, they become more attentive to the smaller issues surrounding the means of saving, which necessitates a reduction in current consumption. These particulars may be unpleasant. As a result, the choice shifts from the unpleasant to the pleasant, or from saving to spending, resulting in a lower-than-expected savings rate3.

Another explanation for people's inability to save money is a condition of learned helplessness. This is human behaviour induced by a lack of conviction in one's ability to overcome weakness. Individuals frequently generalise based on prior repeated attempts to succeed. When individuals regularly fail to save, they begin to assume that they have no control over their spending. Above all, they cease attempting to save money.

Refer to scholarly research on Inter-temporal Choices, The Construal Level Theory, and Learned Helplessness to learn more about why individuals fail to save.

In her paper, Explaining Why So Many Households Do Not Save4, Annamaria Lusardi from Dartmouth College and the University of Chicago summarises -

…approximately thirty per cent of households whose head is close to retirement have done little or no planning for retirement.

Planning is shaped by the experience of other individuals: individuals learn to plan for retirement from older siblings. They also learn from the experience of old parents. In particular, unpleasant events, such as financial difficulties and health shocks at the end of life, provide incentives for planning. In addition, planning affects wealth levels as well as portfolio choice. Individuals who plan are more likely to hold large amounts of wealth and to invest their wealth in high-return assets, such as stocks.

She finishes the abstract by asserting,

“Thus, planning plays an important role in explaining the saving behaviour of many households.”

Suggested reading

1. Why Don’t Americans Save More Money? - The Atlantic

Individuals with adequate capital must not only save but must also preserve and utilise their current capital to generate income or growth. While their primary purpose in most cases is to invest funds to achieve their financial goals, many with insufficient capital would also prefer to continue with their savings plan, if any. The finer intricacies of the requirements of those with wealth, on the other hand, are best grasped by studying how capital was created.

Many of those who have money have accumulated it through saving from their earnings over time. Those who work save regularly from their paychecks or bonuses. Others in business or profession sell their business or a portion of it, releasing revenues that were previously reinvested in the business year after year. These folks, regardless of financial sufficiency, are on the safer ground since they have most likely recognised the need for saving. They can maintain the savings strategy and recognise the need of preserving and growing their present cash. The timely attainment of their financial goals is primarily based on the successful use of resources, which may necessitate advice, as we shall examine later in the coming posts.

The remaining others acquire capital either through inheritance1 or through the unexpected receipt of wealth in the form of a lottery win, another type of win, or a windfall gain.

Inheritances, no matter how large or small, are more likely to be obtained in the middle of the life cycle stage. People risk squandering their whole acquired money if they do not have a savings strategy in place, demonstrating a lack of both knowledge and motivation to save. They must devise a savings and investing strategy to protect and expand this capital. Winnings are based on random, one-time events. These can occur at any point in life. Many studies have been performed over the world, and most people who obtain unexpected money finish up broke within 5-7 years. The most pressing need for these people is assistance in understanding how this money might help them attain their life goals.

When they reach the age of maturity2, which is 18 years old, a small but growing segment of the younger generation acquires money in the form of investments made on their behalf by parents or grandparents in their names as minors. As previously stated, this group's spending habits are most likely to be influenced by family norms. Otherwise, financial education activities are most effective if initiated at the age of adulthood. It is questionable whether discussions about the importance of long-term savings would be beneficial to this demographic. There is little doubt that, because of the power of compounding, these young people may profit the most from a long-term savings strategy.

You must save frequently from your earnings to accumulate capital.

The need to provide for himself, his family members, and other loved ones with some of life's most important and expensive necessities, as well as certain indulgences, is fundamental to human nature. If a person saves enough money, he may be able to cover these expenses on time. While each person's needs are unique, aside from being influenced by their life cycle stage, several motivations for raising cash are shared by most people. These are some examples:

• The establishment of an emergency fund to address unanticipated financial challenges that may emerge at various stages of life.

• Having enough money to buy an expensive product, such as a vehicle, motorcycle, an Apple MacBook, or an Apple iPhone.

• Funds for children's higher education

• Having adequate money for a down payment on a property purchased with a mortgage.

• Arranging cash for children's marriages

• Funds to renovate an old house.

• Establishing a retirement fund to generate income for comfortable retirement life.

• Create private trusts for philanthropic purposes.

Some of the needs listed above may not apply to everyone. A person's marriage or family situation, nation or culture, goals, and family beliefs all affect their expenses. An unmarried person with no plans of marriage or adoption may not have any requirements relating to marriage or children's education. Some of the above-mentioned motives to save may be seen as needs in some cultures and cravings, desires, or wishes in others. For example, in certain cultures in India, providing for children's weddings is regarded as an inescapable obligation, whilst in others, it is only a choice gesture. Similarly, some families believe it is their responsibility to cover their grown children's post-graduation expenditures.

A major source of concern for those who lack capital is the cause of the lack of capital. It's fine if the reasons are tied to their youth or a recent start in income generation. Not having capital is a big problem for individuals who have been earning for many years or are much further along in the life cycle stage. This might be due to a lack of awareness (lack of intent) or a lack of control over needless spending (lack of competence), or both.

While this may surprise some, there are people, especially the young, who spend as if the notion of saving does not exist in our world. These people do not believe in squandering an opportunity to spend money. They believe that spending money is their prerogative, arguing that, as you may have heard many times, "after all, we only live once!" Analyzing their spending habits may indicate that they have already spent half or more of their future earnings by purchasing items in equivalent monthly payments (EMI). An equated monthly instalment (EMI) allows a person to postpone payment for a purchase by providing an option to pay in equal monthly instalments rather than paying the entire amount at the time of purchase. In a typical case, someone with Rs. 10,000 to spend would shop worth no more than Rs. 10,000. However, with the market flooded with offers of EMI to pay over the next 12 months, he may wind up shopping for up to Rs. 1,20,000. If the money is spent on a need, the EMI might be a blessing. Otherwise, the person may end up squandering the annual potential savings on cravings without even realising it. These needless expenses, which were a danger to monthly savings before the introduction of EMI, have now become a threat to the entire year's savings, if not more. Such people have little desire to save and are more likely to fall into a debt trap in their youth. Here is one quote from the findings of research1 on the consumption patterns of the young adult market,

...the young consumers studied show a relaxed attitude to debt and consumer purchasing, with nonessential consumption seen as "deserved" and a "reward" for behaviour such as studying or working. Social pressure is found to be the key driver of consumption choices in this group, with most spending decisions made impulsively.

Most persons with no capital are those who, although knowing the need of saving, fail to do it. The first of the two most prevalent reasons why people fail to save is the effect of a person's family's spending patterns during their childhood. According to research, parents may play a crucial impact in the internalization of social and other behavioural norms2 for children.

Families often maintain standards by threatening punishment for breaking a rule. Any norm becomes an attitude when an individual develops a resistance to its violation and develops some type of internal deterrent to its breach. Several studies have been undertaken, including one in Sweden3, which found that around 56% of individuals felt uncomfortable with debt. This is a significant proportion, indicating that conventions and attitudes can have a big effect.

The survey also revealed that preceding generations were, for the most part, uneasy with debt. It did, however, point out that the trend has been reducing over time, and the number of parents who are uncomfortable with debt is far higher than the percentage of children who are uncomfortable with debt.

The second reason is the emotion that prevails in a person’s mind when his first few attempts to save money fail. Such people begin to have the unshakable notion that they are just not capable of saving money. This phenomenon, known as the impact of learned helplessness4, will be discussed later.

Yes, we must devise, implement, and monitor a savings strategy. A savings plan is a practice of setting away a specified amount of money from income regularly, generally every month, to accumulate capital. The capital may be necessary for any of the reasons stated in the preceding post. The saving plan is always in the form of an investment1 of a portion of the income or augmented by an investment of the saved money.

A recurring deposit (RD), which is made with a post office or a bank, and a systematic investment plan (SIP), which is done with a mutual fund, are two simple examples of savings plans. While both include a predetermined amount of money being invested in a specific deposit or program on a certain day each month, the amount being fixed is not required for a savings plan. The amount may vary from month to month; more significantly, the amount must be saved/invested each month to be withdrawn within a suitable time frame.

Individuals may require a savings plan for a variety of reasons. To better comprehend the motivations for a savings plan, a larger contrast may be established between those who do not have any existing savings, also known as "people without capital"2, and people who do have savings, also known as "people with a capital".

The following quote may provide some food for thought.

Text within this block will maintain its original spacing when published

By sowing frugality, we reap liberty, a golden harvest.

Given the way the world works today, it's nearly impossible for anybody to exist without money, and because expenses are permanent, but earnings are not, people, including you, are required to save for a variety of reasons.

• You must save from income in months with lower expenditures to collect enough funds to sail through months with higher expenses. Expenditure during festival months such as Deepawali and Christmas are prime examples. Individuals who do not save throughout the previous months may not have enough money to spend during these months.

• You must save to cover unexpected, unusual expenditures in the event of an emergency, such as a protracted illness, an accident, job loss, and so on. This is especially critical for persons who do not have proper protection against these circumstances.

• Given that some necessities of life may not be met by a month's salary, you must save to accrue sufficient funds to meet these. Some examples of these necessities include the acquisition of any item, such as a vehicle or a house; preparing for international trips; and planning for children's higher education and marriage. These requirements or aspirations, which frequently arise because of family responsibilities, are referred to as financial goals.

• Certain people do not have decent job security. Many others who rely on a business or profession for a living are vulnerable to income downturns or losses. If you fall into this group, you must save money to feel financially secure.

• Many people want to spend their lives decently, either without working at all or working as they please, in a way that brings them enjoyment and a sense of purpose. Such people want to obtain financial independence so that they won't have to worry about their expenses. They must save and invest strategically to generate passive income as a substitute for future income.

• Human beings have a finite working life. Everyone eventually stops working for a living. This may occur due to old age, health concerns, personal decisions, work terms, or other compulsions, whether within or outside of an individual's control. Just as some people wish to construct an income nest to attain financial freedom and cover their expenditures, practically everyone, including you, needs to create such a nest to cover their expenses once they stop working. Under normal conditions, a person in India ceases working at the age of 60, even if he lives until the age of 85. As a result, you must save and prepare for your retirement life of over 25 years. Failure to save for retirement frequently results in an extremely unsatisfactory retirement life.

Before you proceed, could you please describe the most frequent spending and saving habits?

(This part is mostly for geeks.)

It is fascinating to observe that various people have distinct consumption and saving habits.

1. Individuals aim to smooth consumption over time and thus consume less if their average long-term income is expected to be lower than their present income.

2. Individuals plan and adapt their consumption and saving across their life cycle to smooth consumption1.

3. People delay present expenditure to protect themselves against future income uncertainty.

4. Similarly, the buffer-stock hypothesis proposes that people regulate their spending based on a goal of asset accumulation adequate to smooth consumption given predicted future income.

While many people have a high potential to save, their actual saving is negative. They spend more than they earn. They borrow money regularly through loans, often known as going into debt. They are unaware that by spending more than their income, they not only squander their future income but also diminish the amount of future 'potential savings' since borrowing interest, a necessary expense, is added to the list of expenses in the coming months. The longer the loan term, the higher the interest rate and the lesser the potential savings.

This does not imply that the debt is bad or that it should be avoided at all costs. Borrowing may be quite advantageous in some instances. Individuals frequently borrow, and appropriately so, to acquire beneficial things that they would not be able to get using their present wealth. Apart from offering great ease of life, these beneficial assets also aid in the reduction of some additional expenditures. For example, while borrowing to buy a house or an automobile raises spending by adding the burden of interest, the bought assets lower the cost of rent or conveyance. Furthermore, the benefits of such assets offset the net rise in1 expenditures because of borrowing. In rare circumstances, people borrow because of a cash flow mismatch—an expenditure must be paid for before receiving revenue. These borrowings are acceptable if they are used only to bridge cash inflow and outflow gaps and are for a limited period. Those who are familiar with the notion of financial planning would see that these circumstances may be easily avoided by keeping an adequate amount of very short-term money, often known as emergency savings.

When determining the necessity for borrowing, consider if it is for a need or a want. A desire can be postponed if it cannot be avoided for whatever reason. Individuals who are low on cash should either moderate their desire or postpone it till a more opportune moment. Borrowing, rather than limiting their desires, will exacerbate their financial problems.

That got my attention. What about the effect of shopping on EMI?

Individuals all over the world are getting accustomed to spending money they have not yet earned. This is due to a phenomenon known as credit.

Most people use credit in a variety of ways. The most common example is credit cards. Another example of credit is purchasing something in instalments. In the market, this is referred to as an EMI purchase, which stands for equated monthly payments. When a consumer purchases something on EMI, he is given the option of paying the entire amount in one lump sum or predetermined monthly payments in the future. In essence, this service delays payment by a few months while enhancing the consumer's spending power. However, this option has the unfortunate consequence of causing users to overspend. They end up buying something far more expensive than they could afford based on their existing wages, or they overspend on stuff they don't need. Successful investors who have attained financial independence will tell you that distinguishing between necessities and desires is critical to their success. Many will also argue that achieving a balance between desires and requirements is half the battle in any savings plan. It is commonplace for many customers to spend significantly more than they would have if credit had not been available to them. This occurs because their desire takes flight, due to the EMI facility.

While there are many different types of EMI, the most appealing to consumers is "no-cost EMI." The consumer is not charged interest in this type of EMI. In essence, investors pay the product's actual cost in EMIs. Many experts feel that a no-cost EMI is a mutually beneficial arrangement between a product seller, a financing bank or company, and the customer. The customer acquires high-priced goods and joyfully pays for them in monthly instalments, acknowledging that he is doing so without incurring any interest costs. The finance company not only earns a percentage of the seller's margin but also gains an extra client to market its other products, and the seller, who shares a portion of its margins with the financing company, gains access to a specific market for a category of its products.

An EMI of this type provides customers with the impression that they have not been charged for the credit provided by the vendor or credit card issuer. However, consumers should keep in mind that "nothing comes for free." What the Reserve Bank of India has to say about "Zero Percent Interest Finance Schemes for Consumer Durables"2 is crucial.

“Banks should refrain from offering low / zero per cent interest rates on consumer durable advances to borrowers through adjustment of discount available from manufacturers/dealers of consumer goods since such loan schemes lack transparency in operations and distort pricing mechanism of loan products. These products do not also give a clear picture to the customers regarding the applicable interest rates. Banks should, also, not promote such schemes by releasing advertisements in different newspapers and media indicating that they are promoting / financing consumers under such schemes. They should also refrain from linking their names in any form/manner with any incentive-based advertisement where clarity regarding interest rate is absent.”

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Saving, in its most basic form, is the amount of money that is not spent. It also refers to the act of putting money away for future expenses. Saving, when used in the context of a habit, refers to the process of individuals routinely putting aside some money from their income to accumulate capital.

He who buys what he does not need steals from himself.

Because money is earned and spent regularly, the term "saving" is used for that period, such as weekly or monthly savings. However, this phase may or may not be tied to the income-earning period. In reality, it may be necessary to select an appropriate timeframe to compute savings while planning, whether for investing, budgeting, or otherwise. Because most individuals, at least in India1, earn every month, they are inclined to calculate their savings based on their monthly expenses. This approach is frequently incorrect, and a year is a considerably better period to examine. A year not only captures the monthly ups and downs of expenditure, particularly discretionary expenditure, but it also allows for the estimation of certain expenses incurred at different times of the year due to infrequent irregular activities such as festive celebrations, travels, emergencies, and so on. Another advantage of measuring savings over a year's time frame is that it includes spending for months when monthly expenditure exceeds monthly income2.

How can I calculate my savings potential?

When determining our savings potential, we must consider the obligatory, or unavoidable, costs. These expenditures are related to the essential demands of living in general and cannot be avoided. They include food, housing, clothes, communication, commuting, and so on. The surplus of income over unavoidable costs is the amount of potential savings, which is the maximum amount that an individual might save in each working cycle. But it is not what individuals end up saving since they prefer to spend their money on things that are either discretionary or avoidable. These costs are tied to a person's desires in life.

A want is a desire for anything that individuals could live without but prefer not to. Some people spend very little money on what they desire, whereas the majority spend a lot. In truth, most individuals seek money their entire lives to achieve what they want or to fulfil their aspirations. The real saving is the remaining income after deducting the expenses for these desires from the potential savings.

To save more, it is evident that an individual must simply reduce the unnecessary expenditure; nevertheless, individuals give significantly more attention to the unavoidable portion of it. While most people don't bother managing their costs at all, others spend much too much time looking for cheaper solutions to meet their requirements rather than limiting their desires. The worrisome and hidden side of this inclination emerges, much to an individual's surprise, when he progresses from one life cycle stage to another.

Over time, giving in to desires becomes a habit, transforming it into a necessity, and an individual is unable to handle the increased expenditure caused by new changes in life. With inadequate savings, a person who is accustomed to prioritising wishes resorts to borrowing as the only way to fulfil requirements. In this setting, it is not uncommon to see banks or consumer credit companies offering a wide range of loans. A bit more on needs and wants shall be discussed in future.

How should savings be calculated in practice?

The most common way is to deduct annual expenses from annual income after taxes. Annual expenses comprise both obligatory and discretionary spending, as well as additional expenses that are likely to be incurred in addition to monthly expenses, such as expenses for holidays, festivals, other festivities, parties, and so on. The average monthly savings would be calculated by dividing the total by 12.

It should be noted that this figure is only an average. The real amount saved each month might be lower or more. Also, people receiving wages or salaries should keep in mind that their real savings may be higher than this figure, as their in-hand income is frequently net of retirement or pension savings.

EMIs paid on any form of purchase, excluding those made for investment purposes, must be considered expenses. For example, if the second house is meant to be an investment, the EMI paid on the second house may be considered a saving. While this amount is considered saving, it is not instantly available to fund future expenses and hence is not called liquid savings.

The term saving is intriguing. There are two perspectives on this. A person may regard saving as an activity, implying that he may do something that will result in savings. The alternative, more accurate, way to look at it is as inaction, the outcome of not doing anything with money; the result of not spending.

Saving is essentially the opposite of spending. Individuals do not save as a direct activity; rather, they save because of not spending money. The essence of saving is how a person spends his money. People who need to save must refrain from spending. If people want to acquire the practice of saving, they must first create the habit of not spending or learn to spend on needs only when necessary.

Don't confuse 'saving' with 'not spending'

However, not spending money will not necessarily result in savings. While you may stop spending money on some occasions, you may not be actively conserving that money. This would frequently result in overspending elsewhere.

"I got fantastic discounts and saved Rs. 2500 when shopping today!"

The person who said this did not save anything. He just did not pay the full price for whatever he bought. But, we could say, he increased his chances of saving money. He can do so by placing Rs. 2,500 in a long-term investment account that is isolated from spending for a reasonable period.

Our mind, deliberately or unknowingly, develops comfort with a certain level of balance in our bank accounts1 by the end of each month. We often check the account balance, and if it is going to be higher than we expected, we spend more. Banking technologies, notably online and mobile banking, have made it easier to keep track of our finances frequently.

It is tough to grasp how our mind operates, and temptations frequently overpower us. In the absence of a well-defined budget and savings goal, we may strive to save some money on some items, but we will almost always end up overpaying elsewhere.

An efficient strategy to improve savings is to instantly transfer the exact amount of money 2 out of your bank account and into your investment once you realise you have spent less on a planned expenditure.

That makes sense! Can you, however, provide some insight into people's saving habits?

People's spending patterns may be divided into many categories but they mostly lie on two extremes. Either they spend a lot or they save a lot. In the first situation, they risk not having enough for future requirements. The latter reduces the quality of life. People must learn how to save and spend money. Financial stability requires a sense of balance. What may make problems worse, at least for some, is that this awareness of the balance takes time. To make matters more complicated, by the time people begin to acquire a sense of balance, they are either about to or have already moved on to the next chapter of their lives.

This shift in the life cycle, for example, from 'Married' to 'Married with kids,' causes irrevocable changes in expenditure requirements, most notably an increase. Except in the "post-retirement" life stage, each year of adult life raises the requirements (individual or family) of adults, resulting in a rise in monthly spending. The growth may be boosted further based on changes in individual ambitions, which are, in turn, heavily influenced by changes in the aspirations of society. Nonetheless, finding the appropriate balance is not difficult if a person recognises the need of saving while still having moderate ambitions.

For the great majority of individuals, saving is what is left over after paying all of one's bills. This tendency implies that they prioritise current spending above planning for future needs. Most of the time, this is not on purpose. It has more to do with a person's lack of awareness of future costs and financial innumeracy3. Financial planners realise that people are more likely to meet their future requirements if they save enough from their present income to develop wealth in line with their future requirements and financial objectives.

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