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Saving vs. Investing: Understanding the Key Differences

Often, you have heard about words like ‘saving’ and ‘investment’.

But did you know that savings and investment are two separate concepts?

The words “Saving” and “Investing” are sometimes used interchangeably, but when it comes right down to it, we should be engaged in both, separately, to secure our better financial future.

If you’re not sure whether it’s time for you to start investing, or if you should focus on saving, the answer depends on your financial goals, risk tolerance, income-expenditure sheet, budget, time horizon and financial situation.

Here is the difference.

The difference between Saving and Investing

Saving ~ putting money aside gradually, typically into a bank account. People generally save for a particular goal, like paying for a car, a deposit on a house, or any emergencies that might come up up. Saving can also mean putting your money into products such as a bank time account.

We save for purchases and emergencies. We save for things that need a vehicle to sit in, available when we need them and have low risk of losing value. It is important to track your savings, put a deadline or timeline to your goals and a value.

For example, if you are saving for your annual family vacation, you might want to earmark Rs. 3000 to save in 9 months, to withdrawal in April. You then know how much you need, how much to save monthly and the ability to take the money, without fee to spend on that treasured vacation.

Why bother saving?

There are three main reasons for saving regularly:

  • For emergencies: to make sure there’s money available if something unexpected happens, like your car breaking down or medical emergency.
  • To fund luxuries: this might include a holiday or buying a new car, or things such as a tablet, computer or new phone.
  • To live comfortably in the future: although it might seem very far away, once you stop working your income will go down and you’ll probably have to rely on money you’ve saved to keep up your standard of living.

Investing ~ using some of your money with the aim of making it grow, by buying assets that might increase in value, such as stocks, mutual funds or property.

When investing, it is important not just to invest, but invest wisely and you will have a better return, when you invest early. Understanding different investment vehicles, what they are for and how to use them will be imperative to being successful. We invest long term, for our children’s college fund or children’s marriage expenditure funding or retirement funding. We use specific vehicles that allow for growth, like these.

If your children have 15 plus years before they go to college for higher education or to start their career, you can invest monthly in a vehicle, like Mutual Funds SIP (Systematic Investment Plan) or any other instruments that will allow for withdrawals when your child goes to college. Long term college funding plans can help you to direct that goal, successfully.

The ultimate purpose that works behind the investment is the creation of wealth which can be in the form of appreciation in capital, interest earnings, dividend income, rental income. Investment can be made in different investment vehicles like stocks, bonds, mutual funds, commodities, options, currency, deposit account or any other securities or assets.

As investment always comes with a risk of losing money, but it is also true that you can reap more money with the same investment vehicle. It has a productive nature; that helps in the economic growth of the country.

Saving

-Short-Term: Ready to go
Saving is typically for smaller, shorter-term goals in the near future (usually three years or less) like going on vacation or having money for an emergency.

-Ready access to cash
A savings account gives you access to ready cash when you need it. But many savings accounts do limit how often you can take your money due to high interest rate like Yes Bank or Kotak Mahindra Bank @ 6.0% pa or more. Ask at your bank branch to get the clarity on your saving account terms and conditions.

-Minimal risk
If your money is in DICGC insured savings account, it’s at minimal or no risk, because your funds are insured by the DICGC (Deposit Insurance and Credit Guarantee Corporation). That means that if anything ever happened to the bank, the DICGC insures each person’s money to at least Rs. 100,000.

-Earn interest
You can earn interest by putting money in a savings account, but savings accounts generally earn a lower return than investments.

Investing

-Long-Term: Achieve major goals
Investing can help you reach bigger long-term goals (at least four to five years away), like saving for a child’s college education or child’s marriage expenditure funding or buying your dream home or retirement funding.

-Harder to access cash
When you invest your money, it’s typically not as easy to get your hands on it quickly as compared to a savings account.

-Always involves risk
You may lose some or all of the money you invest.

Investing does not guarantee a return, and it is possible to lose some or all of the funds invested.

-Potential for profit
Investments have the potential for higher return than a regular savings account. Your investments may appreciate (go up in value) over time. This increases your net worth, which is the value of your assets (what you own) minus your liabilities (what you owe). If you sell for higher price than you invested [/double_paragraph] [/row]

Inflation Rate – The impact on your savings and investments

Many people are used to ignore the impact of inflation on savings and investments. They never think about it and it’s impact on their money due to low financial literacy in India.

Understanding impact of inflation is crucial to  savings and investing because inflation can reduce the value of investment returns.

Inflation is bad news for savers, as it erodes the purchasing power of your money. Low interest rates also don’t help, as this makes it even harder to find returns that can keep pace with rising living costs.

The obvious impact of inflation on your savings is that the purchasing power is erroded.

For Example

This means that if you stash Rs. 100 under the mattress today and inflation is 3% per year when you come back a year from now your Rs. 100 will buy 3% less stuff. Put another way you would need Rs. 103 to buy the same amount of goods a year later. When you extend this to 10 years you might think that it would mean that you would need Rs. 130 to buy the same amount of goods but because of the effects of compounding you would actually need Rs. 134.39.

Just imagine the impact of inflation on your retirement planning or any other financial goal planning.

The money in your bank saving account will lose money means – it’s purchasing power.

Remember, Don’t keep more money in your savings account.

Inflation poses a “stealth” threat to investors because it chips away at real savings and investment returns. Most investors aim to increase their long-term purchasing power. Inflation puts this goal at risk because investment returns must first keep up with the rate of inflation in order to increase real purchasing power.

For example, an investment that returns 3% before inflation in an environment of 4% inflation will actually produce a negative return (−1%) when adjusted for inflation.

If you do not protect your portfolios, inflation can be harmful to fixed income returns, in particular. Many investors buy fixed income securities (like Bank Fixed Deposit or Bonds) because they want a stable income stream, which comes in the form of interest, or coupon, payments. However, because the rate of interest, or coupon, on most fixed income securities remains the same until maturity, the purchasing power of the interest payments declines as inflation rises.

In much the same way, rising inflation erodes the value of the principal on fixed income securities.

Suppose you buy a five-year bond with a principal value of Rs. 100. If the rate of inflation is 3% annually, the value of the principal adjusted for inflation will sink to about Rs. 86 over the five-year term of the bond.

Investing in equities can potentially provide better protection against inflation than fixed deposit accounts or bonds.

However, investing in equities carries a high risk of losses and you must be prepared to accept that you could get back less than you put in and that the value of your investment may not keep up with inflation.

Putting money away in a savings bank account can be classified under ‘savings’ but not ‘investment’. This is because in a savings bank account, your money lies idle. Too much savings and too little of investment doesn’t create wealth.

Savings, alone cannot constitute to the increase in wealth, because it can only accumulate funds. There must be the mobilisation of savings, i.e. to put the savings into productive uses –means investing.

There are a number of ways of channelizing savings, one of them is an investment, where you can find limitless options to invest your earnings. Although risk and returns are always associated with it, but when there is no risk, there is no profit.

Rule: First save for essential, then invest (from whatever is left).

Keep Moving……………

“You have to learn the rules of the game, and then you have to play better than anyone else.” ~Albert Einstein

I am a CERTIFIED FINANCIAL PLANNERCM , CHARTERED WEALTH MANAGER® For the moment, I have shared my experience growing up with you because it had a tremendous impact on how I do what I do. If you have a question about your own financial situation please connect with me.  I’d be delighted to try to be of service.

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