Saving and investing : Are they two different things?
Saving and investing : Mr A and Ms B are best friends who share many common interests. But their take on finances could not be different. Mr A likes to save his money, to put it away for a rainy day. Ms B prefers to invest, as she wants her money to grow quickly. The two of them often have long discussions about which technique is better: Mr A stands up for the savings team, Ms B for investments. Passersby frequently do not realize what the fuss is all about: Aren’t saving and investing the same thing?
No, they are not. Time to distinguish between the two.
- You save money to meet regular and unexpected expenses.
- You invest money to grow your wealth.
- Time horizon
- Savings are designed to help your cope with monetary needs within the short term.
- Investments work only over the long-term, because you need to allow the money to accumulate and grow.
- The risk in a savings instrument is quite low. These are typically high-security channels for your finances.
- Investments involve more risk to your principal, as a lot hinges on how the fund in question performs in the market. Some investment channels are more risky (e.g. equity) than others (e.g. debt funds).
- A savings instrument offers you only a limited and low rate of return (a savings bank account gives about four percent).
- The percentage of returns on an investment instrument is higher (as much as 14 percent in the case of mutual funds).
- Savings offer high liquidity to enable you to meet short-term expenses.
- Investments are low liquidity, because your money needs that much time to grow.
- Types of instruments
- Common savings instruments include savings bank accounts, money market accounts, savings certificates, government bonds, etc.
- Common investment instruments include stocks, mutual funds, ETFs, real estate, precious metals, etc.
This brings us to the big question: Should you save or should you invest?
Fortunately, unlike Mr A and Ms B, you need not choose one over the other. A good financial portfolio creates a balance between both, savings and investments. Both have their own roles to play in the financial life of an individual. Savings are what you use to fix a leaky tap or a broken window, pay for your child’s school trip, take a parent to the doctor, and so on. Investments are what you use to carry out a full-fledged remodelling of your house, send your child to a foreign university, or pay for a planned surgery. As you can see, savings and investments are both required for leading a financially stress-free life.
Of course, when you have some money available, you would have to decide between saving and investing. Typically, you should have about six months’ savings in place before embarking on an investment plan. Thereafter, start diverting any excesses into investment instruments.
Your goals would have an impact on your decision. Use the five-year timeline as a thumb rule: If you need the money before the five years are out, then save; if not, then invest.