What Is the Difference Between Saving and Investing?
Introduction – Savings vs Investments
Saving and Investing are the two terms used interchangeably. Savings vs Investments are two different activities. Savings help in short-term financial goals, while Investments help in achieving long-term goals. Thus,they have different purposes and play different roles in your financial strategy making. It is very important to be clear on the fundamental concepts before you begin your journey of building wealth and finding financial independence.
What is Saving?
- Saving is putting aside money left over after paying your monthly bills and liabilities into your drawer, savings account etc. Thus, we usually put savings into the safest places or products that allow you to access your money at any time. Savings have almost zero risk of erosion and therefore the returns on savings are also extremely low.
- It gives no or negative returns (negative due to inflation). Post-tax returns from saving should beat the inflation so that it maintains its buying power and also generates returns over and above the inflation for building the wealth.
- So, if saving just beats inflation, is it not good enough, well it is. But when? In the short term. When your objective is preserving your wealth for your short term goals (which are realizing within 3 years). In such case, you cannot afford to put all of money into asset classes which have high risk high return correlation like equity which can be volatile in the short term.
- Savings account, liquid funds, FDs, post office schemes, Insurance plans, etc are savings instruments that meet the purpose of achieving short-term goals.
What IS Investing?
- When we are talking about long term goals, we cannot simply rely on saving instruments. Here, the term Investing comes into the picture.
- Investing is Putting your ‘Saved money’ into the avenues with an expectation of gaining post-tax positive returns well over and above the inflation so that you can build wealth.
- We can achieve it by investing into Debt funds, Debt-oriented & Equity oriented hybrid funds, equity funds, pure equity, etc. In short, investing is letting your money generate more money.
- Investing is a discipline and systematic approach to make your money work harder and compund into a larger corpus over a long period.
Why Saving Is Important?
Let us understand the critical role that savings play.
- Savings are a must for your emergencies. You could lose your job, you may plan to start your own business or you may be hit by a medical emergency. In these circumstances you need liquidity and a liquidity back-up to fall back upon. That is why, it is always advisable to hold 5-6 months of your monthly earnings as liquid savings. In fact, it is the comfort of savings that allows you to invest more prolifically.
- Secondly, the process of investing begins with savings. Let us first understand savings as the difference between earnings and expenses. Here is where the first steps towards wealth creation begin. You must not look at savings as the residual but look at expenses as a residual. As your income grows, keep raising your savings target and work your expenses accordingly. Out of the money you save, allocate a small portion to liquid assets like bank deposits and liquid funds and the rest to long term wealth creation. That is why savings are so important.
- A good savings mix ensures that you do not have to break your investments at a future date unless the situation is absolutely demanding. Breaking your investments means that you miss out on future wealth compounding opportunities. Forced breaking of your investment could also have negative implications for your tax liability and to your long term goals pegged to these investments.
Investments Hold the Key to Your Future…!!
Investments bridge the gap between your goals and your current situation. Investing works on compounding principles and longer you stay invested, better it is. So here is why investments are so critical to your long term financial goals.
- Over a long time frame, the risk inherent in investments tends to get neutralized and works in favour of the risk-return trade-off of these investments. Even on a risk-adjusted basis, these long term equity investments tend to be much safer and more prolific.
- The investment in equity related products has two key advantages. Unlike debt, equity is best positioned to overcome the risk of inflation over a period of time. Secondly, a diversified product like a diversified equity fund is structured to capitalize on different economic cycles alternatively over a longer time frame.
- Normally, financial planning begins with a conservative estimate of equity returns. Over the longer run, they actually tend to perform much better. That means, the funding gaps in your plan automatically gets taken care of. That is very important considering that quite often your outlays cannot keep pace with your rising needs. That is where compounding comes in handy and that is why investments actually matter!