CHAPTER: 3

SAVINGS AND
INVESTMENTS
3.1 MENING OF SAVINGS AND ITS IMPORTANCE

3.2 MEANING OF INVESTMENTS AND ITS IMPORTANCE

3.3 A FUNDAMENTAL STUDY OF PORTFOLIO

MANAGEMENT
3.1 Meaning of Savings and its importance:

Savings are generated when a person or an organization abstains from present

consumption for a future use. Savings are something autonomous and induced by the
incentives like fiscal concession or a income or capital appreciation. However, increased
savings does not always correspond to increased investment. In the nineties, savers came
from classes except in the case of the population who were below the poverty line. The
growth of urbanization and literacy has activated the cult of investment. Since the nineties the
investment activity has become more popular with the change in the Government policies
toward liberalization and financial deregulation.

Saving is income not spent, or deferred consumption which is obtaining for present
for future use. It is the excess of income over expenditure. Savings also include reducing
expenditure, such as recurring costs. In terms of personal finance, saving specifies low-risk
preservation of money, as in a deposit account, versus investment wherein risk is higher.
Saving is sometime autonomous coming from household as a matter of habit. But bulk of
saving come for specific objective like future needs, contingencies, interest income,
precautionary purpose or growth in future wealth leading to raise in standard of living.

The note worthy point is that Saving differs from savings. The former refers to the act
of increasing one’s assets, whereas the latter refers to one part of one’s asset. Saving refers to
an activity occurring over time, a flow variable, whereas savings refers to something that
exists at any one time, a stock variable. Saving is closely related to physical investment, in
that the former provides a source of funds for the latter. By not using income to buy
consumer goods and services, it is possible for resources to instead be invested by being used
to produce fixed capital, such as factories and machinery. Savings can therefore be vital to
increase the amount of fixed capital available, which contributes to economic growth.

The central statistical organization has defined savings as the excess of current
expenditures over income at macro level and is a balancing item on the income and outlay
account of producing enterprises and households, government administration and other final
consumers. For the purpose of estimating domestic savings, the economy in a closed set up
has been divided into three sectors, household sector, private corporate sector and public
sector. The savings at household sector, which account for the bulk of savings, are measured
by the total of financial savings and savings in physical assets. The savings in financial form

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include savings in currency, bank deposits, non-bank deposits, life insurance funds, provident
and pension fund, claims on government, shares and debentures, units of UTI and trade debts.
Of course, currency and deposits is voluntary savings and motivated by transactions and
precautionary motives and are governed by interest income and other incentives.

Importance of Savings:

Savings refer to that part of income which is not consumed. A person does not know
what will happen in future, money should be saved to pay for unexpected events or
emergencies. Without savings, unexpected events can become large financial burdens.
Everyone can agree that savings money as early as possible will help one and his family to
achieve more stable life than someone who has no savings. Long term habit of saving money
is a way of protecting someone from natural adversity that comes in life and helps an
individual to be secured financially.

Following are the importance’s of savings:-

1. To meet unexpected expenditure in life:

Savings help to face those expenditures in life confidently which may come
unexpectedly. Unexpected events or emergencies can be tackled with the help of
savings. It ensures that the saver is financially independent in the future and does not
rely on debts.
2. Savings act as an inducement for investment:
If a person has considerable savings, he will have a feeling that he is able to meet
some unexpected expenditure and to face moderate risk. This feeling induces him to
make investments. Savings can provide an excellent source for future business
ventures as capital. It also allows for exploring sleeping talents and other interests that
may increase one’s income.
3. Education of children:
One of the most important things a person can do is to educate his children. In today’s
world education is very essential and adversely very expensive. Therefore, savings is
very important on the side of education also. Quality based education will provide a
great sense of accomplishment and peace of mind for a person.

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 4. Family security: It is an important fact that a person wants to give security to his
family against some unexpected danger. Even though in the process of income
determination, income of an individual is taken over his entire life span. So people are
very much aware of the stability and security of their family. It forces them to save a
portion of their income.
5. Achieve a feeling of self reliance: A habit of savings gives people the ability to enjoy
independence and power to do things. Savings enables a person to purchase goods and
services whenever it is required.

3.2 Meaning of Investment and its importance:

Investment is the commitment of money or capital to purchase financial instruments

or other assets in order to gain profitable returns in the form of interest, income, or
appreciation of the value of the instrument. When an asset is bought or a given amount of
money is invested in banks, post offices or some other financial institutions, it is expected
that some return will be received from the investment in the future. On the other hands
investment generally results in acquiring an asset, also called an investment, if the asset is
fairly priced to be worth investing, it is normally expected either to generate income, or to
appreciate in value, so that it can be sold at a higher price (or both).

In finance, investment is putting money into an asset with the expectation of capital
appreciation dividends or interest earnings. The term investment is usually used when
referring to a long term outlook. This is the opposite of trading or speculation, which are
short-term practices involving a much higher degree of risk. Investment usually involves
diversification of assets in order to avoid unnecessary and unproductive risk.

Types of Investment:

Investment has different types:

1. Autonomous Investment:
Investment which does not change with the changes in income level, is called as
Autonomous or Government Investment.

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2. Induced Investment:
Investment which changes with the changes in the income level is called as induced
Investment. Induced Investment is positively related to the income level.
3. Real Investment:
Investment made in new plant and equipment, construction of public utilities like
schools, roads and railways, etc., is considered as Real Investment.
4. Financial Investment:
Investment made in buying financial instruments such as new shares, bonds,
securities, etc. is considered as a Financial Instrument.
5. Planned Investment:
Investment made with a plan in several sectors of the company with specific
objectives is called as Planned or Intended Investment.
6. Unplanned Investment:
Investment done without any planning is called as an Unplanned or Unintended
Investment. In unplanned type of investment, investors make investment randomly
without making any concrete plans.
7. Gross Investment:
Gross Investment means the total amount of money spent for creation of new capital
assets like Plant and Machinery, Factory Building, etc. It is the total expenditure made
on new capital assets in a period.
8. Net Investment:
Net investment is Gross Investment less Capital Consumption (Depreciation) during a
period of time, usually a year.

If a person has purchased one kg of gold for the purpose of price appreciation
or a consumer durable like washing machine for the flow of services, it is his
Investment. If he purchased an insurance plan or a pension plan, it is an Investment.
Investment comes with the risk of the loss of principal sum. The investment
that has not thoroughly analysed can be highly risky with respect to the investment
owner because the possibility of losing money is not within the owner control.

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Modes of Investment Avenues:
In today’s economy many channels or modes of making investments are
available with the investors. Different investments confer different sets of rights on
the investors and different set of conditions under which these rights can be exercised.
Some investments are very simple and direct, whereas some are quite complex and
require a lot of analysis and investigation. Some investments are traditional and
familiar, whereas some are new and unfamiliar to the investors.
Every investors have different priorities. Some prefer low risk securities; whereas
some want higher return and they are willing to take more risks. Some investors want
liquidity whereas the others may be interested in long term investment.

There are a number of alternatives exist in the economy. Various alternatives are as
follows:
A. Direct Investment Alternatives:
Direct investments are those where the individual makes his choice and takes
his own investment decisions. The direct investments may be fixed principal
investments, variable principal investments and non-security investments:
 Fixed Principal Investments: in fixed principal investments, the
principal amount and the maturity amount are known with certainty.
The examples of these investments are:
i. Cash.
ii. Savings-Bank Account.
iii. Savings Certificates
iv. Government Bonds.
v. Corporate Bonds.
vi. Corporate Debentures.
 Variable Principal Securities: in variable principal securities the
maturity value is not known with certainty. The examples of these
securities are:
i. Equity shares.
ii. Preference shares.
iii. Convertible Debentures and preference shares.

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  Non-security Investments: The examples of non-security investmens
are:
i. Real estate.
ii. Mortgages.
iii. Commodities.
iv. Business ventures.
v. Art, Antiques and other valuables.

B. Indirect Investment Alternatives:

Indirect investment alternative is an important and rapidly growing segment of
our economy. In indirect investment, the investors have no control over the
amount invested. The investments are entrusted to the care of particular
organizations. These organizations manage the funds on the behalf of
investors with the help of group of trustees. Examples of indirect investment
alternatives are:
i. Pension fund.
ii. Provident fund.
iii. Insurance.
iv. Investment companies and
v. Unit trust of India.
An investor has various alternatives avenues of investment for his
savings to flow in accordance with his preferences. Savings are
invested in assets depending upon their risk and return characteristics.
The objective of investors should be to minimize the risk involved in
investment and maximize the return.

C. Transferable Financial Securities:

These securities can be transferred easily. Such securities are:
i. Equity shares: the holders of equity shares are the owners of the
company. They have voting right in the meetings of the company.
They have a control over the working of the company. Equity
shareholders get dividend after paying it to the preference
shareholders. They may get a higher rate of dividend or may not get

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 anything. On the liquidation of the company they get their capital back
after satisfying it to the preference share holders.
ii. Preference shares: these shares have two preferences as compared to
other shares. There is a preference for payment of dividend when the
company has distributable profits. The second preference is regarding
of capital at the time of liquidation of the company. Preference share
holders do not have voting rights but they are paid a fixed rate of
dividend. The investors who want a regular income even though the
rate, may be less will prefer such shares.
iii. Debentures: a company can raise long term loan by issuing debentures.
A debenture is an acknowledgement of debt. In the words of Thomas
Evelyn, “A debenture is a document under the company’s seal which
provides for the payment of a principle sum and interest thereon at
regular intervals, which is usually secured by a fixed or floating charge
on the company’s property or undertaking and which acknowledges a
loan to the company.” An investment in debentures fetches a fixed and
regular rate of interest.
iv. Savings certificates: another avenue for investment is the purchase of
savings certificates. The rate of interest and the maturity period are
mentioned on the certificates. In some certificates there are tax benefits
also. The important saving certificates are:-
 Indra Vikas Patra.
 Kisan Vikas Patra.
 Sukanya Samridhi Accounts.

v. Government securities: the securities issued by central government, state

governments and quasi government securities. These securities have
maturity period between 3 and 20 years and carry different interest
rates. Government securities are not preferred by the investors because
of low interest rates and longer period of maturity. These are purchased
by institutions like commercial banks, LIC, financial institutions etc.
under statutory obligations.

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 vi. Money market securities: there are debt instruments of short period
duration. In Indian money market three securities; Treasury bill,
certificates of deposits and commercial paper are issued.

D. Non-Transferrable Financial Securities: some financial securities are non-

transferable. Some of these securities are as follows:

i. Deposits.
ii. Tax-Sheltered Savings Scheme.
iii. Public Provident Fund Scheme.
iv. National Savings Certificate.
v. Life Insurance.

E. Mutual Funds: mutual funds offer another opportunity for common investors.
Such funds have been very popular in USA. In India, a number of private and
public sector funds have been given permission by Securities and Exchange
Board of India. A mutual fund is an institutional device through which
investors pool their funds to invest in a diversified portfolio of securities, thus
spreading and reducing risk.

F. Gold, silver and precious objects: in India, an investment in gold given much
importance. Indian women are very fond of wearing gold ornaments. In
marriages too gold ornaments form an important part of dowry. So much
being the craze for these metals, an investment in gold and silver is liquid.
There are avenues for investment in precious stones and art objects also. These
things have aesthetic appeal besides investment value. People in the upper
strata of the society invest in such things and common people do not explore
venues of such investments.

G. Financial derivatives: derivative is one which is derived from an existing

product. Mathematically defined it is a variable derived from an existing
variable. Financially defined derivative is a product whose value is derived
from the value of an existing product. In other words, a derivative is a
financial product, which has been derived from another financial product or

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 commodity. Derivatives are financial contracts which derive their value off a
spot price time series, which is called the “underlying.”

Features of an Ideal Investment programme:

While investing investors’ money, they must have some definite ideas
regarding the features their investment must possess. These features must be
consistent with the objectives, preferences and constraints of the investors.
These investments must also offer optimum facilities and advantages to
investors as far as the circumstances permit.

The investors generally form their investment policies on the basis of the
following features:-

i. Safety.
ii. Liquidity.
iii. Regularity and stability of Income.
iv. Stability of Purchasing Power.
v. Capital Appreciation.
vi. Tax Benefits.
vii. Legality.
viii. Concealability.
ix. Tangibility.

Scope of Investment Management:

i. Identification of investors’ requirement.

ii. Formulation of investment policy and strategy.
iii. Execution of strategy
iv. Monitoring of Portfolio.

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Importance of Investment:

Investment is the commitment of money or capital to the purchased of interest,

income or appreciation (capital value) of the value of the instrument. According to
Benjamin Franklin “an investment in knowledge always pays the best interest.” Good
investors create the backbone of the society.
Following are the importances of Investment:
 Financial freedom:
First and foremost thing an investment gives is financial freedom. If anyone
invests money from the beginnings, he needs not to worry about the future financial
needs. As future is uncertain and there may be a situation where a large amount of
money is required to get out of that situation, one must indicate the habits of savings
and investment. It may be because of children’s education, marriage or medication.
 Increase knowledge:
Investment does not mean buying and selling only, it need a thorough study in
the various aspects of stock market and the company, it will increase knowledge in
various fields.
 Safety:
Inflation is constantly increasing the cost of goods and services and decreasing
the value of money. One needs to invest it well so that the return will be higher and
the value of every rupee is augmented.
 Increase wealth:
Besides, making financially sound, investment makes one wealthy also. As
one invests more and more money for a long time, it will increase his return and
definitely makes him richer and wealthier.
 Tax benefits:
Investing selectively allows one to enjoy tax benefits. There are a number of
post office tax rebate schemes which can give one tax benefits, some of them are like
National Savings Certificate, Public Provident Fund and Senior Citizen Savings
Certificate etc.

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 3.3 A fundamental study of Portfolio Management:
Portfolio management is the art and science of making decisions about
investment mix and policy, matching investments to objectives, asset allocation for
individuals and institutions, and balancing risk against performance. Portfolio analysis
deals with the determination of future risk and return in holding various combinations
of individual securities. On the other hand, one of the most important terms in
portfolio management is ‘Diversification’. The term Diversification means spreading
of one’s investment in different avenues for reducing unsystematic risks. The
traditional belief of Diversification, it means “Not putting all eggs in one basket.”
Diversification helps in the reduction of unsystematic risk and promotes the
optimisation of returns for a given level of risks in portfolio management.
Diversification of investment may take any of the following forms:
 Different assets e.g. gold, bullion, real estate, government securities etc.
 Different Instruments e.g. Shares, Debentures, Bonds, etc.
 Different Industries e.g. Textiles, IT, Pharmaceuticals, etc.
 Different Companies e.g. new companies, new product company’s etc.

Proper diversification involves two or more companies/industries whose

fortunes fluctuate independent of one another or in different directions. One single
company/industry is always more risky than two companies/industries. Two
companies in textile industry are more risky than one company in textile and one in IT
sector two companies/industries which are similar in nature of demand a market are
more risky than two in dissimilar industries.
Some accepted methods of effecting Diversification are as follows:

i. Random Diversification:
Randomness is a statistical technique which involves placing of companies in
any order and picking them up in random manner. The probability of choosing
wrong companies will come down due to randomness and the probability of
reducing risk will be more. Diversification should, therefore, be related to
industries which are not related to each other.

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 ii. Optimum Number of Companies:
The investor should try to find the optimum number of companies in which to
invest the money. If the number of companies to small, risk cannot be reduced
adequately and if the number of companies is too large, there will be
diseconomies of scale. More supervision and monitoring will be required and
analysis will be more difficult, which will increase the risk again.
iii. Adequate Diversification:
An intelligent investor has to choose not only the optimum number of
securities but the right kind of securities also. Otherwise, even if there are a
large number of companies, the risk may not be reduced adequately if the
companies are positively correlated with each other and the market. In such a
case, all of them will move in the same direction and many risks will increase
instead of being reduced.
iv. Markowitz Diversification:
Markowitz theory is also based on diversification. According to this theory,
the effect of one security purchase over the effects of the other security
purchase is taken into consideration and then the results are evaluated.

Objectives of Portfolio Management:

 Security of Principal Investment:

Investment safety or minimization of risks is one of the most important
objectives of portfolio management. Portfolio management not only involves keeping
the investment intact but also contributes towards the growth of its purchasing power
over the period. The motive of a financial portfolio management is to ensure that the
investment is absolutely safe. Other factors such as income, growth, etc. are
considered only after the safety of investment is ensured.
 Consistency of Returns:
Portfolio management also ensures to provide the stability of returns by
reinvesting the same earned returns in profitable and good portfolios. The portfolio
helps to yield steady returns. The earned returns should compensate the opportunity
cost of funds invested.

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 Capital Growth:
Portfolio management guarantees the growth of capital by reinvesting in
growth securities or by the purchase of the growth securities. A portfolio shall
appreciate in value, in order to safeguard the investor from any erosion in purchasing
power due to inflation and other economic factors. A portfolio must consist of those
investments, which tend to appreciate in real value after adjusting for inflation.
 Marketability:
Portfolio management ensures the flexibility to the investment portfolio. A
portfolio consists of such investment, which can be marketed and traded. Suppose, if
your portfolio contains too many unlisted or inactive shares, then there would be
problems to do trading like switching from one investment to another. It is always
recommended to invest only in those shares and securities which are listed on major
stock exchanges, and also, which are actively traded.
 Liquidity:
Portfolio management is planned in such a way that is facilitates to take
maximum advantage of various good opportunities upcoming in the market. The
portfolio should always ensure that there are enough funds available at short notice to
take care of the investor’s liquidity requirements.
 Diversification of portfolio:
Portfolio management is purposely designed to reduce the risk of loss of
capital and income by investing in different types of securities available in a wide
range of industries. The investors shall be aware of the fact that there is no such thing
as a zero risk investment. More over relatively low risk investment give
correspondingly a lower return to their financial portfolio.
 Favourable Tax status :
Portfolio management planned in such a way to increase the effective yield an
investor gets from his surplus invested funds. By minimizing the tax burden, yield can
be effectively improved. A good portfolio should give a favourable tax shelter to the
investors.

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Principles of Portfolio Management:

Certain basic principles, which can be applied to all investment decisions, are as follows:

1. In portfolio management, emphasis is put on identifying the collective importance of

investor’s all holdings. Individual securities are important only to the extent they
affect the aggregate portfolio.
2. Every portfolio should cater to the particular needs of the investor. People have
different tax slabs, knowledge etc. portfolio strategy should cater to the unique needs
and characteristics of the portfolio holder.
3. Larger returns on investments come only with larger risk. The most important
decision to be made is the amount of risk that is acceptable. This is not an easy
decisions since t requires that the investor has some idea of the risk and expected
returns available on many different classes of assets.
4. The risk associated with a security depends upon when the investment will be
liquidated. Risk is reduced by selecting securities with a pay off close to when the
portfolio is to be liquidated.
5. One has to be careful in evaluating the risk and return from securities. Imbalances do
not last long and one has to act fast to profit from exceptional opportunities.

Process of Investment Decisions:

The process of investment decision involves five stages:-

1. Investment policy:
Investment policy provides the raw material for the portfolio
management. In this stage various investment assets are identified and their
features are considered. The goal of investment policy is to decide which stock
to be held in an investment portfolio.

The formulation of investment policy requires:-

I. Determination of investible funds or the amount to be invested.
II. Determination of investment objectives
III. Identification of potential investment assets.
IV. Consideration of attributes of various investment assets.

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 V. Allocation of investible funds to various investment categories.

2. Investment analysis:
The main objective of investment analysis is to determine the future
risk and return in holding various blends of individual securities. Portfolio
analysis helps in generating efficient portfolio. to determine the efficient
portfolio, an expected return level is chosen and the assets are substituted until
the portfolio combination with a smallest variance at that return level is found;
an efficient portfolio will be one compared to which no other portfolio has the
same return and a lower risk or the same risk and a higher return.

3. Valuation of securities:
The most important and complex step is valuation of securities.
Investment value is generally taken to be the present worth to the owners of
future benefits from investments. An appropriate set of weights have to be
applied with the use of forecasted benefits to estimate the value of the
investment assets. Comparison of the value with the current market price of
the asset allows the determination of the relative attractiveness of the assets.

4. Portfolio construction:
The goal of portfolio management like all other human endeavours is
utility maximization. Both risk and return affect utility. Optimum portfolio
allows a trade off between expected returns and risks which depend on the
preference of the individual investor. Portfolio construction requires
knowledge of the other different aspects of securities also e.g. growth of
principal, liquidity of asset, etc.

5. Portfolio evaluation and revision:

Portfolio management is a continuous process. After selection of
portfolio the next step is that of evaluation from time to time depending on
market conditions. The primary motive of evaluation is to improve
performance. Effective portfolio evaluation requires an investor to balance

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 what he has against available alternatives. Portfolio must be constantly
evaluated and periodical adjustments in holdings may be made indicated by
the changing economic climate. Portfolio has also to be revised so as to best
serve investors objectives. Portfolio revision involves both realizing that the
currently held portfolio is not optimal and specifying another portfolio to hold
with superior risk-return characteristics. The investor must balance the costs of
moving to the new portfolio against the benefits of the revision. Portfolio
revision considers both the buying and selling of securities as expectations
change over a period of time.

Investment Portfolio of average Household in India:

In India, a large number of savers, barring the population who are below the
poverty line. In a poor country like India, it is surprising that its saving rate is as high
as 23% of GDP per annum and investment at 28% of GDP. But the return in the form
of output growth in as low as 5% to 7% per Annum.

The average Indian household saves around 60% in financial assets and 40%
in physical assets. Of those in financial forms, nearly 60% is held in cash and bank
deposits, as per the latest RBI data and they have negative real returns or return less
than the inflation rates. Besides, a proportion of 30% of financial savings is held in
form of insurance, P.F., Pension Funds etc., while another 4% is in government
instruments and certificates like Post Office Deposits, N.S Certificates, and Public
Provident Funds, National Savings Scheme etc. The real return on insurance, P.F., etc
are low and many times lower than the average inflation rates. With the removal of
many tax concessions for investments in P.O. Saving’s instruments certificates, etc.,
they have also become less attractive to small and medium investors. Household
savings witnessed strong composition shift form financial to physical savings during
the period 2006-07 to 2012-13. Net addition to the physical assets of the households
including investments in construction, machinery and equipment and change in stocks
constitutes the savings of household in physical assets. With a significant reduction in
the growth of construction activity in 2012-13, physical savings rate by households
have also declined. The failure of the construction sector to pick up strongly in 2013-
14 indicates that the increase in physical savings of household in the year may have
been muted.

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