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Suresh Krishnamurthy

Trends in household savings indicate a continuing preference for bank term deposits and apathy towards equity investments. This lop-sided investment strategy does not augur well for the financial security of households.

IN 2003, many experts predicted that the sharp decline in interest rates would force many Indian households to turn savvy investors. The robust response to the disinvestment offers of the Government would have even fuelled their optimism. Many confidently predicted a shift from bank deposits into equities. Alas, nothing of that sort seems to have happened, as the data on household savings in financial assets reveal.

In 2003-04, household investments in equities and in mutual funds remained insignificant. Households piled ever more of their money into the ubiquitous bank deposits. Like catching a plunging knife, households were putting more and more into bank deposits just when interest rates were being marked down sharply.

Nothing could kill returns on an investment portfolio more surely than this tremendous preference for bank deposits, especially when inflation is ruling well above 6 per cent.

The data also makes a mockery of the fund industry claims that it is now branching out into tier-two cities to expand business. That less-than-Rs 5,000 crore invested in mutual funds in 2003-04 suggests that the fund industry has not gained much share even in the top four metropolitan cities. There is still much work for it to do.

Shrift to asset allocation: Part of the reason for the explosive growth in bank deposits could be rational. The trend could be explained by the entry of more and more people into the banking network.

If more people were starting to save and they could manage only about Rs 10,000 in a year, the deposit base would keep rising. In addition, with only a meagre sum at their disposal they cannot afford to take the risk of investing in equities.

However, if that were the only reason, a similar robust growth in investments in equities would have also happened, as existing depositors moved into equities. That suggests the continuing, inexplicable preference for bank deposits, even by those who can afford to invest in equities.

Indian households have for long preferred bank deposits. This preference did not matter when long-term deposits were earning 10 per cent plus. Returns of that order for what is essentially a risk-free investment is more than adequate to cover for inflation. Things have now changed considerably. Still, households appear to generally ignore the need for proper asset allocation.

Assertive investors: Many would attribute the prevailing trend to a lack of investor education. It is, however, possible that the behavioural phenomenon of over-confidence too is at work here. Anecdotal evidence suggests that investors equate mutual funds to UTI and assert that investments in mutual funds are not worth it. They also believe that equity funds destroy value. Their experience of investing in equities and technology sector funds in 1999-2000 also does not help matters. It is difficult to convince such investors who are confident that bank deposits are the only safe and reliable option.

This steadfast preference for bank deposits, however, only leads to a transfer of wealth from the households to banks and the borrowing community, particularly the Government. Their failure to enhance allocation to equities, especially during a year in which stocks rose in value by more than 100 per cent, could hurt them dearly.

Inflation is now running hot, and all of the Rs 1,60,000-odd crore parked in bank deposits by households would already be eroding in value. The least that such households could have done was to shift to post-office term deposits, which offers better returns than bank deposits. Even that option appears to have been largely ignored.

Equities are imperative: The need for equities in any portfolio that is worth more than a few lakh rupees cannot be over-emphasised. To build even a conservative portfolio, exposure to equities of 15-20 per cent is necessary. Investment of less than 15 per cent or no exposure to equities is a riskier approach.

In addition, only equities can help combat inflation. Households that do not have a strategy to combat inflation are only risking their financial security.

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