Today we are going to learn two important concepts of Personal Finance namely Saving and Investing. It is very important to understand the concepts in detail. Saving and investing often are used interchangeably, but there is a difference.
What is Saving?
Saving is the process of setting aside the money you don’t spend now for emergencies or a future purchase. Saving is income not spent or done due to deferred consumption. Saving happens when your expenditure is lower than your earning. So saving refers to any income not used for immediate consumption.
for example, if your earning is 100 Rs and your expenditure is 80 rs. The remaining 20 rs is your saving. This 20 rs can be kept with you as hard cash or deposit in the bank. So any amount that is are being kept aside in cash form or your saving account for your future needs can be termed as Saving.
What is Investing?
Investing starts after saving. Investing means putting your saved money into something to make a profit or get an advantage. Investing is a process in which you put your money in those assets classes such as stocks, bonds, mutual funds, or real estate with the expectation that your investment will make money for you. In investing you expect to earn decent returns on the money you invested. Thus it is a process to make your money work for yourself.
Let’s learn key differences between saving and investing and what suits you the best.
1. Holding Period
In saving the holding period is short. We mainly save for the immediate purchase which we have planned in the next 6 months to 2 years. We need to keep our money ready so we prefer to keep aside the cash or put this in a bank saving account. Whereas Investing is mainly done to create wealth. It is for long-term life goals such as retirement, children’s education, or marriage. The goals must be 7–10 yrs away so that the invested money can earn decent returns.
The term liquidity means how quickly we can access our money when we need it. In saving the liquidity is very high as saving is mainly done in the form of cash or bank saving account. We can easily withdraw our money from the bank. Money is easily and quickly available. But whereas in investing access to your money depends on the kind of investments you make. Open-ended equity mutual funds schemes allow you to redeem your investments at any time. But you need to pay short-term capital gain tax if you withdraw money within one year of investment. Money invested in PPF or ULIPs is locked for the stipulated time as per the product feature. The money which is easily accessible can be also be spent easily on unwanted things. So saved amount can easily be splurged but this does not happen in Investing.
3. Risk accessed
We usually keep aside savings in our bank saving account or keep the hard cash at home. Money kept in a Reputed bank account is safer than the cash kept at home. Cash can be stolen or spoiled easily. Besides these risks, saving suffers from major risks and that is called Inflation. The returns which we get from ideal cash are zero and the interest earned on the bank saving account is negligible as compared to prevailing inflation. So actually we lose the value of money in saving.
Whereas investing carries a risk in returns earned. If money is invested in stocks or equity mutual funds it carries market risk. Returns are not assured and the principal is also at risk in market-linked investment. Debt funds and bonds also carry credit risk, interest rate risk, and default risk. Government-backed debt instruments such as PPF and EPF are safe where returns are assured and the principal is protected but they carry an inflation risk. Returns that we get maybe at par with the current prevailing inflation rate or maybe less. The risk in investing varies according to the channels of investments. Investing wisely may give returns much higher than savings in the long run.
4. Returns earned
Risk and Return vary inversely with each other. It means when risk is more there is a possibility to earn higher returns. And when we take the lower risk we earn less return. In saving all our money lies in saving bank account where risk is minimal but we earned only 2.5% interest. If we put money in a bank fixed deposit we may earn a maximum of 6 % interest. However, investments in equity-based mutual fund schemes carry a much higher potential for long-term value growth. We can get returns up to 10 to 12% p.a. Quality investments have higher potential returns than regular savings if compared for a long term of 10 years. It leads to wealth creation in long run.
5. Investor’s choice
The right thing is to first identify your purpose. Why do you want to save or invest your money? Check whether your goals are short-term or long-term. For a very short-term goal, saving is a must. We should have ready cash for any emergency. The contingency fund is one form of saving only, which is created by investing in the liquid fund and bank FD. But in the long run, consider your changing needs, limited income sources, and inflation; savings may fall short for bigger financial goals. Investments are made typically for bigger financial goals which may seem impossible now but would be possible in the time to come if they are wisely planned today.
The prudent investor creates a financial plan based on asset allocation and does goal-based investment to minimize the risk and maximize the returns.
Thus Saving and Investing go hand in hand. They cannot be done in isolation. One must understand the difference between these two concepts for optimum utilization of our hard-earned money. Wise persons make their money work for themselves. So do smart work and not only hard work.