What is the preferred duration of holding an investment in India?
Let us classify investment and saving holding of individuals as long term and short term. Long term is 10 years or more, while short term is less than 10 years. If we take a look at data that RBI releases every year on Components of Household Savings, we get an idea of the proportion of savings that is kept in long term saving avenues or instruments and the proportion of savings that is kept in short term saving avenues or instruments.
From the RBI Table (Click on RBI data 1997 to 2016 to download the Table) on Components of Household Savings, we can classify the following as short term and long term savings.
Short Term Savings Destinations
Currency: That is money kept in the form of cash
Bank deposits: Usually the deposits have tenures of less than 10 years
Claims on Government: This refers to the deposits kept in post office and also instruments like NSC, Indira Vikas Patra, etc., – i.e. money saved with the Government. These are again mostly short term in nature
Non-banking deposits: This includes savings in NBFCs, Chit funds, etc.
Long Term Destinations
Life Insurance Funds: Typically the maturity of life insurance endowment policies are 15 to 20 years or even more.
Pension and Provident Funds: Again typically money is invested in these instruments for very long periods, more than 10 years, even stretching to 40 years sometimes.
Distribution of Savings Long Term vs. Short Term
The RBI data shows that in 2016-17, Indians invested 67 % of their savings in short term investments, while 33 % of their savings was in long term investments of life insurance, pensions and provident fund. Let us study the distribution for a longer period of time. If we look at RBI data for the last twenty years, you will see that the distribution between short term and long term remained more or less the same. The preliminary data available in the Report of the Committee on Indian Household Finance, 2017 (see Report of the Committee on Indian Household Finance) shows that for the year 2016-17 also the distribution of short term to long term was similar. For 20 years the investors behavior and his responses to risk and duration have been almost the same. Think and let us know through the Comments Box why you think this is so.
What do we learn from this data?
The 20 year data on the savings by households (individuals) tells us that out of every Rs. 10 that Indians save, Rs. 6.70 is saved for short term needs and Rs.3.30 is saved for long term needs. Data that is so consistent over a 20-year period gives us irrefutable evidence that people know how to distinguish between short term and long term needs and take their saving decisions accordingly. We need to understand from every customer what his long term and short term needs are and sell to his long term needs
What are the short term needs of individuals?
There are many short term needs of individuals. Daily cash expenses at home, school fee of children, emergency expenses at home, unforeseen medical needs, the need to maintain houses by repairs, painting, etc., the need to buy clothes, the need to buy appliances such as washing machine, fridge, etc., purchase of a car or motorcycle, and many more. To meet these needs, individuals would prefer to save in such instruments, where they can lay hands on the money if required. Most of the short term needs (other than monthly domestic expenses) usually come in an unplanned manner. Hence there is a real need to keep money in such a manner that can be quickly accessed. Most people think about the short term needs at regular intervals since there is family pressure to do so. For example the family may want a new television, or a new mobile or a new motorcycle. The bread earner in the family usually is mentally and financially prepared for fulfilling such needs.
The low risk options available to people are: keep cash at home, or cash in a savings bank account, fixed deposits in banks, post office deposits, etc., serve the purpose of getting money when required. The higher risk options are mutual funds, shares, debentures, etc.
What are the long term needs of individuals?
Unlike short term needs, most people are not mentally or financially prepared for long term needs. The general tendency is to postpone planning for the long term. Which is the reason we exist as insurance agents. Our job is to bring to the conscious mind of the customer his long term needs so that he starts thinking about it.
The most common long term needs of individuals are purchase of a house, education and marriage of children, and retirement planning.
For such long term needs people keep their money in life insurance endowment, provident fund and pension fund.
We are in the business of selling life insurance
On an average, Rs. 3.30 is invested (out of every Rs.10 saved) by customers for long term requirements. We are in the business of selling for long term requirements. Our market is Rs.3.30 out of every Rs. 10 invested by individuals. So why should we bother about what the customer wants to do with the remaining Rs.6.70. No matter how hard we try we cannot get a part of the Rs.6.70. We cannot deny the customer his short term needs. We can try to get Rs.3.30, i.e. the 33 % of his savings which he is prepared to invest for long term needs. We should concentrate on this segment – long term needs and long term investments.
Asset Liability Matching
Prudent and wise investors (also shown in the RBI data discussed in this article) invest in long term instruments for long term needs. They do not invest in short term instruments for long term needs. If a person wants to save for daughter’s marriage, he picks a long term savings plan that is low risk, (also see Where Do Indians Save Their Money? ) to ensure that the money will be available for the marriage at the time of the marriage.
Long Term Asset Liability Matching Does not Take Place With Short Term Assets
Suppose he invests in a bank fixed deposit for 5 years, and if the event of marriage is 20 years away, then what will be the situation 5 years later? This cannot be predicted, but 5 years later there are likely to be many demands on how to use the maturing fixed deposit and the chances are that the money will get spent for a purpose other than the daughter’s marriage. For example, suddenly repairs of the house may become important or there may be family demand to buy a car.
On the other hand money invested in mutual funds and shares has 2 issues. One they are risky ( See Are Debt Mutual Funds or Debt Instruments Really Safe ) and two, they are short term in nature. Therefore there is a double risk that the money will not available for the marriage when needed.
Asset liability matching is nothing but matching your future liabilities to an asset you are creating today (such as an endowment life insurance policy) which will mature at the desired time of marriage. All wise investors do so.
Sell for the long term, do not worry about the short term
Exercise for the day
Why do Indians invest 33 % of their savings in low risk and long term investments? Write and let us know – in the comments box below or through email to ashok@iistpune.in and discuss it in your sales team