Financial literacy for common man

Oinam Nabakishore Singh *

All of us need money to meet our needs and wants. To begin with, the first question is what is money? It is defined to be a medium of exchange between buyers and sellers of goods and services. It helps in the smooth transactions, which were not possible in the barter system which existed in primitive society.

With the increasing diversification of human needs and technological advancement, money is becoming digital, where money is not visible to the eye. Paper currency notes are gradually replaced by digital money through the use of digital platforms like G-Pay, Paytm, netbanking, etc. India is a leading country in use of digital payments, where smart phones are used to transfer money between parties.

Money is also a store of value–different currency notes, sums, etc. represent certain units of value. Money helps in assigning value to goods and services. For instance, the price of a car may be ten lakh rupees while the cost of hair cut–a service– may be fifty rupees.

Financial literacy helps in financial planning, savings and investment, expenditure by households, organizations and nations over time, normally for a period of one year. Just as the saying “time is money” is meant to convey the value of time, and need for avoiding wastage of it, money also has time value. One rupee today has different value from one rupee after one year. One may ask as to how that is possible.

Currency note of one rupee today and after one year will have a figure of same one rupee. However, due to erosion or appreciation of the value of one rupee over one year, for instance, its value will decrease or increase corresponding to inflation or deflation in one year. Let us assume that the rate of inflation is ten percent per annum for all goods and services in the economy together.

It means that after one year, the combined cost of all goods and service will be costlier by ten percent. The purchasing power of one rupee will be reduced by inflation of 10 percent–it will become only ninety paisa. How to retain the value of money or rupee over time when the economy witnesses inflation?

The answer lies in increasing the amount or quantity of money by adopting one or a mix of investment in a basket of portfolios delineated here.

The easiest method of investment of small sums or big amounts is using term deposits, commonly called fixed deposits, with commercial banks regulated by Reserve Bank of India or with Post Offices. While the rate of interest of term deposits is modest, it has the advantage of security of the deposits and peace of mind.

The interest earned from term deposits should normally offset the rate of inflation to allow, at least, retention of the original value of money over time. The median interest rate of about 7 percent offered by banks and post offices will lead to accrual of some returns to the depositor. Rate of inflation in December, 2024 is reported to be 5.22 percent.

One negative incentive of term deposit is tax deduction at source(TDS) @10 percent of the interest earned by the bank and crediting it to the account of tax payer. This tax credit can be utilized towards payment of income tax while filing income tax returns. On the positive side, interest income from term deposits upto Rs. 40,000 for individuals, and Rs.50,000 for senior citizens is exempt from income tax now.

The rate of income tax payable on interest income from term deposits is calculated at the rate of tax slab applicable to the individual. In terms of liquidity, terms deposit may be closed at any time before the date of maturity to meet immediate need of fund.

Therefore, for all classes of people, term deposit with commercial banks is safe investment with moderate returns. It was reported recently in the newspaper that former Prime Minister, Dr. Manmohan Singh, chose the route of term deposits with banks to earn a small return.

It is always wiser to use the services of banks to safely keep surplus funds for a certain period of time. Such deposits also help the receiving banks to increase credit to the borrowers resulting in creation of more money out of the term deposits and spurring economic activities. The second option of investment of unused and surplus fund of households and firms is mutual fund.

Mutual funds allow pulling together funds by entities, normally promoted by banks and financial institutions, from investors like individuals and firms. The beauty of this mechanism of mutual fund is that small investors without any knowledge of financial markets of equity and bonds are allowed to access such markets through them.

Mutual fund entities employ experts, who have experience and knowledge of financial markets, regulations by Securities and Exchange Board of India, Income Tax Department, and past performance of financial products like equity and bonds of various companies listed with stock exchanges and their future outlook.

There are many kinds of mutual funds promoted by banks and financial institutions. They vary in many respects–equity based mutual fund, bond based mutual fund, mix of equity and bonds in various ratios– in order to suit the risk return appetite of investors.

Those who are averse to risk of losing the investment may opt for mutual funds, which invest the fund entirely in bonds only. Fund managers may again choose from a wide range of bonds–bonds issued by the Central and state governments or municipalities and bonds issued by corporates having different ratings of safety. Normally returns from bond-based mutual funds are above the returns from term deposits with banks.

On the other hand, equity based mutual funds invest in equity of corporates based on their financial performance and outlook. They are likely to give higher returns although risks of the market is inherent.

In order to spread the risks of investment in a more equities in the market, new and innovative funds like Index funds and exchange traded funds are available in the market. One may take advice from experts on choosing the right mutual fund before investment. Although mutual funds charge some upfront and exit fees from investors, they are popular investment option for many individuals who have surplus funds.

Third option is investing directly in stock market as an investor or trader through a broker. A broker is an intermediary registered with stock exchange as a broker to transact on the stock exchange on its own behalf or on behalf of investors. In India, there are mainly two stock markets–Bombay Stock Exchange (BSE) and National Stock Exchange.

After the advent of digital technologies, trading on the floor of stock market has ended. All trading on a stock market happens through buy or sell orders by using a computer terminal or a smart phone with the app of the broker. Nowadays, brokers are available 24 hours a day as an app, which may be accessed anytime from anywhere.

What one needs is to download the app of the broker and register oneself by providing certain details of bank accounts, Pan Card details, etc. to open a demat account. While there are many platforms for trading on stock market, Kite by Zerodha, which is a broker on BSE, NSE and multi-commodity exchange is easy to use. The fee charged for maintenance of demat account by Zerodha is nominal.

However, while long-term investments in stock market is relatively safe, day trading is extremely risky. One may lose money if investments are made without understanding the market and its volatility.

Nevertheless, there are stories of many people who became very rich through wise investments in stock market. Rakesh Jhunjhunwala, who died a few years back, is called Warren Buffet of India for his success in Indian stock market.

Fourth investment and trading route is commodities market, which is called a derivative market. Here, a contract between two parties–buyer and seller of an underling asset, is traded in the market. Investment in options is considered to be much riskier now as bigger firms are using artificial intelligence to predict the movement of prices of commodities and other assets.

It was reported by SEBI that in 2022, 90% of active retail investors in options derivatives lost US$ 5.4 billion. Human beings are no match of the computing capacity of artificial intelligence, which process huge data to come up with answers to queries in milliseconds. Hence, trading in derivatives should be out of bounds for most of investors.

Fifth investment option is in Ponzi Scheme, where initial investors get good returns from investment by later ones. Manipur has witnessed many instances of Ponzi schemes, which led to loss of hundreds of crores of hard earned money. Promoters of Ponzi schemes play with human greed.

Unfortunately, even wise people fail to ask a simple question, ‘What is the source of income of Ponzi Scheme to pay 3% interest per month on deposits’. They see only the promised return of 3% per month and nothing beyond. One should be careful before making any investment decision. One should always ask a simple question–if my money is in safe hand or not.