Investment Basics: Saving vs. Investing

Financial markets are full of complex terminologies but the most simple ones can be very important to understand, two important terms are Saving and Investing. Let us get our investment basics right and understand Saving vs. Investing!

The most important unwritten rule of creating wealth and achieving the financial freedom is that one should approach “saving” for shorter time period while “investing” for longer time period.

In simple language, you should not save for longer time period but invest. Also, you should not invest for shorter time period, but save.

Saving vs. Investing: Many of us must be confused between two very basic investment terms (1) Saving and (2) Investing. It is a very common confusion because of their very loose uses by many market participants such as traders, investors, mutual fund distributors and agents. The words (1) Saving and (2) Investing are many a times used interchangeably, however if we dig deep down, there two have entirely different meaning and applications.

What are the basic differences between (1) Saving and (2) Investing?

Both of these terms (1) Saving” and (2) Investing” are very important and are related but refer to dissimilar arrangements and can lead to a very different result from each other, impacting financial goals.

What is saving?

Saving can basically be defined as an income that is not spent.

Saving is generally referred to a portion of disposable income that is not used for consumption, essentially whatever is remained in your hands after paying for all the expenditures is saving. We save to build assets with a specific goal in mind like saving for a holiday trip, saving for emergencies or for a very short-term goal.

Also correspondingly, saving also involves reducing expenditures, such as recurring costs. Saving can be classified as putting money into a bank saving account or holding cash. Also, to put the things into perspective, saving is different from savings. Savings is the end result of saving.

If you are saving that means you are putting money aside, bit by bit, for some specific goal. Usually you put saving into cash products such as savings account where you can get accesses to your money at any time. Savings are generally put into safest place or products, allowing easy access with lowest risk, with an expectation of low returns.

What is investing?

Investing is different from saving. You invest your savings to generate income or return. Under investment you allocate your savings with an expectation to generate benefits out of that. The benefits might be capital gain, investment income, dividends, interest, or rental income. The process of investing is of a longer term and for large goals. You invest in riskier products or buy things that increases their value in longer term such as stocks, property or mutual fund etc.

The savings which are invested in these risky products are generally not insured by the government however the risk and uncertainty may lead to higher returns and compounded returns over a longer period of time. There is a tradeoff between the higher risk of investing and the potential for greater rewards.

Saving vs. Investing

Let us take an example and understand the major difference between Saving vs. Investing:

I am able to save Rs. 10,000 monthly and want to understand my savings and investing options. For simplicity purposes, I am considering liquid mutual fund and equity mutual fund as saving and investment products where I can put my money in.

Goal: Build emergency fund of Rs. 1,00,000

Goal: Build a corpus of Rs 10,00,000 for a foreign holiday

Time Period

Short Term (12 Months)

Long Term: 5 Years

Maximum monthly saving

10,000

Products

Liquid Mutual Fund

Equity Mutual Fund

Maximum Expected annual returns

7%

~16%

Total disbursement

1,00,000

6,00,000

Value after desired time period

1,24,000

9,20,000

What if I save for longer term, let us compare then:

Time Period

10 years 10 years

Maximum monthly saving

10,000

Products

Liquid Mutual Fund

Equity Mutual Fund

Maximum Expected annual returns

7%

~16%
Total disbursement 12,00,000

12,00,000

Value after desired time period

17,40,945

29,50,000

See the difference, if I save for 10 years then my savings would grow around 45% whereas if I stay invested for 10 years in a good mutual fund who is delivering around 16% CAGR then my wealth would grow to around 30 lakh (+150%).  That is why we should save money to fulfil our unexpected expenses or urgent money requirements however for capital formation and higher returns we should invest prudently.

Read: NFO Review: Motilal Oswal Equity Hybrid Fund – Will I Invest?

Also, one must understand the impact of inflation on savings. You should always seek to earn a return that is greater than the rate of inflation. Inflation erodes the value of money and purchasing power. Let us understand that by one example:

If you have saved money in a bank’s saving account that pays 6% interest per year. Thus after one year, your savings will grow by 6%. Now, if the inflation rate during that year was more than 6% then you will be able to purchase less than the amount that you began with although you have more money in your pocket.

Commonly asked questions:

Is saving or investing better?

Well, both are equally important and saving complement investing. You cannot invest if you have not saved some money. If you are confused about should you save or start investing, the answer totally depends upon goals, time horizon, risk taking capacity and financial situation.

When should I save or invest?

Let us understand the answer through the below table which is based upon goals and time period:

Goal

Time Horizon Save or invest?

Buying a new Car

1 Year Save

Buying a new Car

5 Year Invest

Building an emergency fund

1 Year Save

Upcoming house purchase

2 Years

Save

Upcoming house purchase 5 Years

Invest

Child’s marriage

10 Years

Invest

Retirement fund 25 Years

Invest

One should always save and build a strong emergency fund to have some financial security if anything goes wrong in your career or any other emergency strikes.

How much is the right emergency fund amount?

A general rule of thumb is your emergency fund should cover at least 3 to 6 months’ worth of living expenses.

Once you have the emergency fund, then you should think about saving for your short-term goal requirements.

Read: India Economy: Breaking down the 8.2% GDP growth

What percentage of savings should be invested?

It is all about how you budget your income and expense. The most popular and easy to implement budgeting method is 50-30-20 method. Under this method:

  • 50% of your income must be spent on all living expenses such as (rent, groceries, transportation etc.)
  • 30% of your income must be spent on lifestyle choices (entertainment, dining out and fun etc.)
  • 20% of your income should be saved and invested

Once you are saving 20% of your income in disciplined manner and have built solid emergency fund and short-term goals are achievable under current circumstances, then you should start investing for your longer term goals. One should only invest if the time horizon of goal is medium to longer term.

While investing, it would be a good approach to seek professional advice from a regulated financial adviser.

Conclusion

Thus, I would suggest you, please don’t confuse between saving and investing. One should invest for the goals that take longer time period while save for the shorter time period goals. Also, do not forget the risks involved in the investing.

Do not make the mistake of investing your savings in riskier products if the time horizon is short-term because these investment options (equity or equity based mutual funds etc.) are very volatile in short-term and value might drop significantly is short time period, impacting your goal planning.

If you want to multiply your wealth and grow your savings then you need to invest in a disciplined and prudent manner so that returns you earn are higher than the rate of inflation.

1 thought on “Investment Basics: Saving vs. Investing

Leave a Reply

Your email address will not be published. Required fields are marked *

error: Content is protected !!