Identifying save-buckets
In principle, saving money is the act of sacrificing some amount of your present convenience for either your future survival or your future convenience. That is all there is to it. And it has to be planned in that order—survival first, convenience second. At this point, I do not want you think about any savings or investment strategy at all, but to identify what are the investments that you make every year.
Identify investments and the corresponding save-buckets.
In India, there are too many places (or instruments) where you can park your money.
- Savings account
- Fixed Deposit
- Provident funds
- Government retirement funds (NPF)
- Bonds (Government, corporate)
- Mutual funds (Equity, Hybrid, Debt, etc.)
- Stocks
- Gold and other precious materials
- Exchange traded funds
- Land assets
The list goes on and grows as both government and corporate come up with newer and cleverer schemes to attract money from the general public. The plethora of choices will only add to your confusion. Clarity is the only antidote and for that you will need a game plan. It is not time yet but I can instead take this opportunity to cut the clutter a bit.
There are only two kinds of instruments
You read that right. There are only two kinds of instruments you should be bothered about. They are known as Debt and Equity. (This classification is based on the asset classes of the instruments. There are other ways to classify financial instruments.)
A debt instrument (or strictly, a debt-based instrument) is a loan that you have given to a financial institution. The financial institution guarantees a fixed return at the end of the tenure. It is easy to identify such instruments as the financial institution will tell you upfront how much you would be getting at the end of the tenure. Savings, Fixed Deposit, Provident Funds, Bonds, etc. are all debt instruments. Even hard cash hoarded at home can be thought of as a debt instrument with zero return. (Zero is still a fixed amount!)
An equity instrument (or strictly, an equity-based instrument) is like buying a fraction of a business. There is no guaranteed return. If the business does well, you will get a good return and vice versa. Instruments such as stocks, gold, land, etc. are dependent on how the market values them and so does your return on the investment.
Before we proceed, here is something you should know about mutual funds. A mutual fund pools in a lot of money from many investors, selects instruments based on some strategy and invests in them. Often there are fund managers who devise a strategy; they decide over what should be the fund allocation amongst all individual instruments; they alter these allocations based on the nature of the fund and the prospect of each individual instrument. We will dive deeper into mutual funds later. For the time being, all you must know is that mutual funds can be equity-based, debt-based or a mixture of both. The last kind is commonly known as a balanced or hybrid fund.
Classifying save-buckets
Unlike the spend-buckets, you don't have to do a rigorous classification at this stage. Create spend-buckets that make sense to you. You might call a bucket PPF for public provident fund, MF-Equity, MF-Hybrid, and MF-Debt for corresponding mutual funds, Stocks for direct stock acquisition, and so on.
Chances are that if you are doing this, you might have never invested based on any financial system. If that is true, your save-buckets might drastically change once you have a system in place. It is alright to go gentle on the classification for the time-being.