The shocking collapse of America’s Silicon Valley Bank is all one is talking or reading about for the past week or so. The collapse of a bank, among other things, puts an individual deposit holder’s savings into trouble.
Paramount amongst all kinds of other risk that has shown up with this event is the deposit holders’ risk of losing their money kept in the bank. Stories of individual depositors withdrawing millions of their personal money, begs the question, why do individuals choose to leave millions in a private savings account?
According to data from the Reserve Bank of India, there is around ₹22 trillion across savings and current accounts for commercial banks and around ₹151 trillion in term deposits.
Compare this with around ₹40 trillion invested in mutual funds and ₹22.8 billion daily cash market volume in equity for individual traders and it’s clear that the popular choice for individuals is to leave money in bank savings and fixed deposits. What’s the risk in that?
What we fail to see thanks to fear
Money kept in bank savings and deposit accounts are meant for safe keeping. There is an assumption that this money is guaranteed to be returned to us whenever we see, additionally, you get a fixed interest on the amount.
It’s money for the future, for business, for children and for emergencies. But it’s also money that’s losing value thanks to something known as inflation or price rise. Annual price rise in the economy is measured by an official index maintained by the Ministry of Statistics and Programme Implementation. Currently it’s at around 6.5% and on average is assumed at 6% for a growing economy like India.
This price rise automatically reduces the value of your money by 6% every year; a basket of stuff which cost you ₹100 last year is likely to be worth ₹106 this year. Your ₹100 from last year won’t be enough. Seen the other way, ₹1 lakh in a savings bank account at the end of a year will fall to ₹94,333.
In five years the value is likely to be down to ₹74,725 and in 10 years just over half the value may remain at ₹55,839. You would have received an interest of around 2.5%-3% every year on this money, but even after accounting for this, your money’s worth will be lower than what it was when you deposited it.
The decline in the value of your money is not apparent because the paper value or face value remains the same; you put in ₹100 and get back ₹100 +2.5%-3% interest in a year.
Our mind does not immediately calculate the impact of inflation in lowering real value, plus the fear of losing money does not permit us to calculate the impact of this risk on the long term value of money.
What we fail to see thanks to greed
Where we seek safety in bank deposits, we seek quick and high returns from equity stocks.
The number of demat accounts in India has trebled in the last four years. According to data from the National Stock Exchange retail investor participation in stock markets is up from around 33% in FY 16 to around 45% in FY 21.
Increased participation, however, does not mean better outcomes or high return.
A recent report from the market regulator SEBI has shown that in FY 22 (April 2021 to March 2022) 9 out of 10 individual traders made losses on average anywhere between ₹1.1 lakh to ₹1.25 lakh. There are 42.4 lakh individual traders in index options with 89% making losses and nearly 21 lakh individual traders in stock options with 82% making losses.
Compare this to the potential of long term returns. Historical data on the value of Nifty 50 index shows that in a twenty year period, those who remained invested for at least 10 years haven’t made negative returns in any given month end and have made at least 10% return around 70% of the time.
Even data from mutual fund industry body, AMFI, shows that around 43% retail investors in equity mutual funds redeem their money before two years are up.
Equity investing has a much higher short term risk of losing money thanks to volatility in values as compared to risk of losing money in the long run, but instead of opting for long term benefits of compounding returns in equities, the retail investor is more interested in chasing quick gains from trading.
This is also an inability to assess risk accurately, this time thanks to greed.
Greed makes investors see only the high return that traders earn from short term trading and the most recent top performance for managed portfolios. This is more visible as its immediate and talked about widely. Seeking one year top performance and trading gains is a lot more attractive than waiting 10-15 years for consistent returns.
What you should see
In bank deposits we see the stability of interest paid and capital safety, inflation risk is not visible. In equity trading we are able to see the possibility of multiplying return in a day or a week, the compounding returns of patient long term investing are harder to foresee.
Assess the risk of investing in a security or a bank deposit and then decide how much you should invest in it.
All your money neither belongs in a bank account nor in the equity markets. For example, emergency money can go into a bank account despite inflation risk, because you may need it anytime and can’t risk volatility in value. However, keeping money that you need for retirement 20 years later in a bank fixed deposit is not going to help you as its value will be much lower.
If equity trading is exciting for you, keep aside 5% or less of your surplus capital to try trading, even if you make losses, it will not impact your future financial needs or current financial position. Trading with money you need for your home down payment in the hope for high return can be reckless if markets correct sharply in a few months’ time.
Leaving millions in a bank deposit is not just risky because the bank may shut down, but also because you are losing real value of money by doing so. Leave what’s necessary and allocate the rest efficiently towards your future. To do this, you need to assess risk accurately with the help of objective knowledge rather than emotional beliefs; the transformation can be very rewarding.
Lisa Pallavi Barbora is a financial coach and founder of moneypuzzle.in