In my first blogpost, I outlined my goal of encouraging low-income groups to invest their savings in mutual funds. Why mutual funds? Are mutual funds suitable investment vehicles for low-income households and economically weaker sections of the society? For the maids, the cooks, the watchmen, the milkmen and the corner-shop paan sellers? I delve into the details of these questions in this post.
Mutual funds — an effective means to combat the hurdles?
In my previous blogpost, I listed four primary hurdles to savings and investments that the low-income group faces. Setting aside the infrastructural hurdles (#3 and #4), the investment product should help in directly or indirectly countering the first two hurdles of the lack of willingness and the ability to save. Let’s discuss the key advantages of mutual funds as an ideal investment mechanism to combat these hurdles as compared to other financial products such as stocks, provident fund or bank savings/fixed deposits.
Disciplined investments: As discussed in my previous blog, the biggest impediment to investing is the lack of a savings habit. Systematic Investment Plan (SIP) is almost revolutionary in this respect. In an SIP, a fixed amount is automatically deducted every month from the bank account and invested in the selected mutual fund.
Investing through SIP inculcates discipline. The direct debits force one into developing a savings habit. Once one sets up the SIP by selecting the amount and number of installments, one just has to ensure that his/her bank account has the money available on the installment date. That’s it! SIP would also force the erstwhile non-saver to cut down on spending to have enough money in the bank account every month. Thus, investing in mutual funds via SIP directly solves the #1 hurdle to saving.
Recurring deposit, a unique term deposit offered by almost all major banks in India, is a similar investment option. Bank account holders can choose to invest a particular amount each month, and are paid a lump sum amount on maturity, which includes the periodic investments and the interest paid on them. However, like fixed deposits, recurring deposits are illiquid in the short-term as premature or mid-term withdrawals are not allowed (or attract a penalty).
Smaller capital outlay, rewarding pool: In India, SIP can be started with an amount as low as Rs. 500 per month. While these bite-sized investments are not financially burdensome every month, the eventual pool of money saved could be large. Over a long term, SIPs can add up to a rewarding sum of money due to the benefits of rupee cost averaging and the power of compounding. This also aids in solving hurdle #1 by easing the development of a savings habit. As the pool grows, it further strengthens the investor’s belief of the power of habitual disciplined savings.
Caters to all types of risk profiles: Unlike those in the high-income group, almost every person in the low-income bracket would be averse to losing any capital. Mutual funds have a variety of fund types, including equity funds, index funds, debt funds and balanced funds. These are further divided into various schemes and payout types (dividend/growth). Cumulatively, mutual funds cover all types of risk profiles and investment horizons. For example, an income (debt-oriented) fund is suitable for a person who is highly risk-averse and has a short time horizon. A person with a long time horizon may invest in large-cap or mid-cap equity funds. This characteristic aids in solving the #1 hurdle by encouraging a savings habit regardless of the risk-taking ability.
High liquidity: Unlike fixed deposits, many mutual funds (liquid funds) can be withdrawn any time — without any charges. Almost all of the rest (excluding retirement funds) can be withdrawn after a year without any ‘exit load’. The high liquidity helps in partially solving #2 hurdle for those who require the money immediately due to their financial vulnerability.
Higher returns and tax efficiency: While higher returns and tax efficiency may be the top-most incentive for the high-income group to invest in mutual funds, that’s not the case with the low-income group. However, it’s undeniable that the low-income group must get the biggest bang for the buck when they invest their hard earned moneys in an investment product. Mutual funds’ post-tax returns have historically been higher than other investment avenues, such as bank fixed deposit, provident fund or corporate debt.
How other financial products fare
In comparison, no other investment product offers all the above advantages of a mutual fund for the low-income investor. Especially, no other investment product will force a savings habit as effectively as mutual fund SIP investment, while offering liquidity.
The Association of Mutual Funds in India (AMFI), the trade association of mutual funds in India, seems to agree to this too. It has recently launched an investor awareness campaign with the tagline “Mutual Funds Sahi Hai”, intended to communicate to prospective investors that mutual funds are the right option for them.
The ad campaigns cover all investor classes, from the rich to the low-income, sending across the message that mutual funds are suitable for all types of risk profiles and investment horizons.
To summarize, mutual funds are a highly effective means of combating the hurdles faced by the low-income group and encouraging their investments. While financial education is the enabler, mutual funds are an optimum route to achieve financial security.