By Adhil Shetty
Saving allows you to preserve your money by keeping it in safe custody. Investing allows you to grow your money, though it comes with some risk.
Many investors often use the terms ‘savings’ and ‘investments’ interchangeably. In reality, there is a marked difference between saving and investing. Let us look at some of the key differences between the two.
In a nutshell, people save to secure the principal. The principal may earn a return without any risk. At the same time, one can withdraw funds whenever one needs it, providing much needed liquidity. On the other hand, one makes investments to get better returns and build wealth over a longer term. Let’s look at a few key aspects that separate savings from investments.
Types of financial schemes/assets
Savings usually employ the safest assets such as savings or current accounts offered by banks. The money deposited in the safe vaults also comes under saving. These are risk-free and may not earn any returns. Investing entails risk. Every asset that gives you a better return than bank deposits involves some risk. Investing in mutual funds, stocks, and gold, where the returns are not fixed, come under investments. The return depends on the companies’ performance, market condition, and general economic sentiments.
Savings are usually short-term. Savings ensure that you can access your principal whenever you want, while investments may not provide you the same assurance. In the short term, returns from investments fluctuate. In the long term, though, investments provide much better returns than savings.
Consider an example. Suppose you plan to pursue higher studies abroad after three years. The cost of the program is Rs. 10 lakh. Currently, you have Rs. 2 lakh in your account. You need to put aside another Rs. 8 lakh over the next three years for the fees. In such a situation, the best option for you would be to save about Rs. 25000 per month in the safest assets that secure your principal and provide you an average return with easy liquidity.
If you invest the same amount in mutual funds or gold, the returns are uncertain. The markets may boom over the next three years and you may get more than your requirement; or, they may crash and you may lose a significant part of the invested amount, derailing your plans.
Savings are more liquid than investments. Liquidity of an asset is the ease with which you can encash it without losing much value. You can withdraw your money from a savings account almost immediately. In case of investments, however, it takes a few days.
For example, redeeming your investment in stocks and mutual funds can take at least two days, and the redeemed value will depend on the prevailing market situation.
Points to keep in mind
First, before you commit to save your money in a bank account or invest in assets, know the nature of the sum and the purpose. If you are left with something extra after meeting all your expenses and securing an emergency fund, investing is the right way to park your extra funds. More importantly, know the risk involved in the type of assets you want to invest before you make an investment decision.
Second, while long-term investments are better, it pays to find the right mutual fund, stocks, and property to invest. If you are unsure about the right stocks or funds, go for blue-chip funds that involve large companies in operation for a number of years. The best way, of course, is to read up on the matter and consult experts who are well informed and trustworthy.
Many people save for the long term. This certainly ensures protection of the capital. However, the huge opportunity costs associated with such long-term savings make it an unviable strategy. For example, a 1% difference in the interest rate on a principle of Rs. 5 lakh for a period of 10 years can result in a difference of Rs. 1 lakh in returns. Hence, if asset A provides an 8% annual return, Rs. 5 lakhs will become Rs. 10.8 lakhs at the end of 10 years. If another asset B provides 7%, the future value will be Rs. 9.8 lakhs, resulting in an opportunity cost of Rs. 1 lakh. With time, this differential will grow.
Finally, there are financial schemes that give better returns than the saving accounts but entail a small risk. You can think of investing in such assets if the stock market or equity funds are not your cup of tea. Government securities, high-grade corporate bonds, bond funds, public provident fund (PPF), and many other government schemes can be a viable alternative if you are ready to take marginal risks.
Savings and investments serve different purposes and follow different timelines. Nevertheless, they both play an integral part in securing your financial future. So, remember to take all factors into account before making a decision, and choose wisely.
No related posts.
No related posts.