Enhancing cash returns

You must channel your monthly savings into investment products to earn the required return to achieve your life goals. Sometimes, individuals keep a significant proportion of their savings in bank accounts. In this article, we will discuss whether such savings can earn higher returns, considering individuals’ desire for greater liquidity. Individuals who are insecure about their finances continually need high liquidity.

Often, such insecurity is a function of the volatility of their income streams — lack of permanent job or a significant proportion of income in variable pay. The issue with keeping money in savings account is that returns are significantly lower than inflation. Such liquidity-seeking individuals should consider keeping their savings in sweep accounts. These are savings account offered by most banks. The amount above the minimum balance required for this type of savings account will be automatically transferred to a fixed deposit earning higher interest.

Suppose this savings account requires a minimum balance of ₹25,000. If you have ₹75,000 in your account, the bank will automatically transfer ₹50,000 to a fixed deposit. If you to have to spend, say, ₹40,000, the bank will automatically transfer (reverse sweep) the required amount from the fixed deposit to the savings account to meet your expenses. Importantly, your money in the fixed deposit will earn higher interest till the time you reverse-sweep. Sweep accounts can also be used by all individuals for parking their contingency reserve funds.

Contingency reserves are meant to provide liquidity to meet unforeseen expenses such as medical emergencies and temporary loss of income. In the absence of inflation-protection products to park the amount, a contingency reserve fund must, at the minimum, protect the nominal value of the fund. Hence a sweep account that offers liquidity, protects nominal capital as there is no market risk, and earns higher returns than savings account.

You must check the associated fees and penalty a bank will charge when your savings account falls below the minimum balance. Note that the interest income is taxable at your marginal tax rate. It may not be worthwhile to link a sweep account with your trading account. The idea that you must earn higher returns on the proceeds from sale of shares till you reinvest the amount is not justified if you consider the capital locked up in loss-making stocks in your demat account. You could consider liquid funds instead.

(The writer offers training programmes for individuals to manage their personal investments)