Saurabh, a 28-year-old individual from Mumbai, started working about three years back. Ever since he received his first paycheque, he has stuck to one principle, “save 10% of the monthly salary.” By adhering to this principle, he has accumulated Rs 4 lakhs by now (excluding his monthly expenses, EMIs, house rent, and so on). However, he talks with a shy smile when asked about his future and how his savings are headed for his life goals, including retirement.
While his discipline and investment principle has brought him this far, there is one drawback he has not considered- his choice of investments. He went with investments like fixed deposits, thinking that his money will be safe (he focused only on wealth protection). However, the mistake he made was not thinking clearly about how this would help him with his long-term goals (retirement, buying a house, or child education).
If you have made the same mistake, let us go through the below investments and clarify why they do not help in wealth building.
Fixed deposits have a purpose, and you cannot make a blanket statement that they are bad instruments. However, when it comes to wealth building, they are not the ideal instruments for you to invest in. In a fixed deposit, the rate of return is fixed at the start date of your deposit. So, you cannot earn more than what you signed up for, even if interest rates in the markets were to rise.
Finally, the most crucial point, by having your money in a bank or an FD, you are losing its purchasing power. Because you are earning a fixed return on these instruments, they cannot offset the corrosive effect of inflation or rising prices.
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- Traditional Insurance Plans
Many buyers invest in traditional insurance plans, lured by the benefits of life cover during the policy term, tax deduction at the time of investment, and tax-free income on maturity. But these traditional plans give abysmal returns.
This is because people buy these policies for mainly three reasons: tax savings, assured returns, and life insurance cover. Considering these points, people end up buying an insufficient cover.
The other reason is that people often ignore or fail to understand the time value of money. The huge maturity amount being projected by traditional insurance plans may mean little after 25-30 years.
- Government Bonds
Whileare one of the safest options available to conservative investors with a low-risk tolerance, it may not be the most appropriate ones. Let’s not forget that the interest on these bonds is taxable, and they have a long maturity of seven years.
And given that the inflation is rising day by day, these bonds generate lower inflation and tax-adjusted returns for those in the 20% and 30% tax brackets.
- Tax-free bonds
The tenure of tax-free bonds is usually 10, 15, or even 20 years. However, tax-free bonds are not recommended to create wealth to meet long-term goals such as retirement, child education, or marriage. These bonds will primarily help you to keep your tax liability at bay and thus are suited when you get a lump sum amount or recurring high-income amounts that will help you save tax.
- Infrastructure Bonds
Most infrastructure bonds that have been launched give returns between 7.5 percent and 8.25 percent. However, the amount of tax you may save through these bonds is too little. Additionally, the five-year lock-in period makes them less appealing.
Investors, especially in the higher tax bracket, may find that they can save very little tax by locking in a considerable amount for 5-10 years.
What Are the Investments Options for Wealth Building?
You need to invest in well-thought wealth management options that can boost your income and help you achieve your investment goals. For wealth building, you need investments that will consistently beat inflation, like ELSS, Hybrid Funds, and ULIPs.
The ELSS mutual funds have the edge over other investment instruments (FDs, government bonds, or infra bonds) as they have the potential to provide high long-term returns and additionally allow a deduction of up to Rs 1.5 lakh under Section 80C of the Income Tax Act, 1961. Although there is a high degree of risk in the investment, market fluctuations average out to provide handsome returns in the long run.
On the other hand, investments in hybrid funds (both debt and equity as asset classes) can offer optimized diversification and minimize risks associated with just one asset class type.
Another interesting avenue foris through ULIPs. ULIPs are that can offer adequate growth of your money and help achieve your goals.
But remember, wealth building is a process that requires discipline and a long-term outlook. You need to keep doing this exercise of wealth-building consistently (for a very long time) without giving up.
As Warren Buffett rightly said, “Games are won by players who focus on the playing field, not by those whose eyes are glued to the scoreboard.” Keep this point in mind, and your probability of success in wealth building will increase immensely.