Short-term saving is about funding goals you hope to achieve in, say, the next five years. Your money needs to be both accessible and secure.

If you put aside a little bit of money each month, it will soon add up to something more substantial. It's affected by three things: rate of return, how much you're putting in and how often you do it.

Rate of return

Rate of return describes the growth you'll get on your savings. For savings accounts, it all comes down to the interest rate.

The interest you'll get over a year on an account is expressed as a percentage. So, if you put Rs.100 into an account which pays 5% interest, after a year you'll have your original Rs.100, plus Rs.5 of interest. (This is the simplified version; with most savings accounts, you'll be taxed on that interest.)

So it makes sense to pick a high-interest savings account that will give you a good rate of return.

Financial boffins have cooked up a useful formula based around rate of return: the rule of 72. This works out how many years it will take for your savings to double – simply divide 72 by the interest rate you’re getting.

This table shows how it works. The higher the interest rate, the sooner your savings will double.

But is it a good idea to make a deposit and forget about it? Well, no. You’re forgetting about inflation.

The amount in your account might be increasing, but its value might not be growing at the same rate.

Confused? Well, if, over time, the inflation rate is higher than the rate of interest you’re getting on your account, then you'll find you can actually buy less with your money.

This effect becomes more noticeable over the long term and is one of the reasons why your long-term savings tactics should be different from your short-term ones.

How much?

That's up to you, what you're saving for and your budget.

You need to consider your current income and outgoings.

If you’ve got debts, such as credit card debt, then you probably shouldn’t think about saving until you’ve paid them off. That’s because it's likely that you’ll be paying more interest on your debt than you’ll get on your savings. You may be congratulating yourself for starting to save but, in fact, you'll be losing money.

What you should do is going to be dependent on your personal circumstances – your age and the scale and type of your debt. It's something you should discuss with a financial adviser.

How often?

To make the most of your short-term savings, commit to saving regularly.

Even a small amount every month will build up over time. It's all to do compound interest. Here's how it works.

Say you put Rs.100 into your savings account. If your savings account has an interest rate of 2% a month (remember, they will quote an annual rate, which will be very low compared to the example), your savings will rise to Rs.102 in the first month. That's Rs.2 in interest. And the next month, it will be Rs.104.04. The interest the second month is Rs.2.04 more than the month before. You're gaining interest on the interest.

These gains may seem small, but think how they could build up over time – adding to your savings.

So, putting off saving is a big mistake. The earlier you start, the more compound interest can work for you.

This chart shows how the compound interest effect really kicks in the longer you have to save. It assumes that you're putting in Rs.1,000 a year, and that your savings are earning 5% interest.

Look at this graph. See the effect of interest rate on various time periods. The longer the time period the higher the increase on the accumulated interest as interest rate increases.

Where to save

The most painless way to save is to set up a monthly direct debit into a savings account. That way money will go into your account before you have a chance to spend it – with luck you won't even realise that it's gone.

So where should we be stashing our savings?

When you’re deciding on the best home for your short-term savings, there are three things to look out for: low risk, easy access and a high rate of return.

Low risk

Low-risk savings accounts are the best place for short-term savings. For example, an emergency fund needs to be as secure as possible – you might need it tomorrow.

There are a lot of accounts to choose from and that’s where the other factors come in.

Access

Recurring Deposit Accounts don't always make it easy for you to get at your money. Always check the terms.

Rate of return

A high rate of return is obviously a good thing for building up your savings.

But there's one more factor to take into account.

Tax-free savings

With most savings accounts, you’ll have to pay tax on any interest that you make.

Need to choose a tax-free savings to get the maximum return.

It makes sense, doesn’t it?

 

Tax rules may change in the future.