Saving v/s Investing

Introduction –

“Savings” and “Investing” for some folks are the same things, but when it comes down to it, they are entirely different things. They have different purposes and play different roles in your financial strategy. 

What is “Saving”

In layman’s terms, savings is income not spent but set aside for future use. Savings are generally kept in cash, or highly liquid assets, that are usually kept for a pre-determined purpose or goal, usually short-term.

What is “Investing”

Investment is using your money intending to make it grow, by purchasing assets that might increase in value in the hopes of a higher return.

Risk, Return and Inflation –

Risk, Return, and Inflation goes together in the world of financial markets. The most optimal situation that any person/investor would want is – Low Risk and High Return, that beats inflation by a good margin. But such a situation does not exist in the real world.

Risk and Return are directly proportional i.e. higher the risk, higher the return. This is the main reason people are averse to investing. Though investing generates high returns, it also carries a high degree of risk. Savings, on the other hand, carry lower risk as compared to investing, and correspondingly, a lower rate of return.

The main issue that arises with saving money (as cash-in-hand) is that it does not grow in value. A Rs. 2,000 note kept today, will have the same value after 5 years, but it’s purchasing power would have decreased significantly due to inflation. So when you don’t earn interest or returns above the rate of inflation, you’re eroding the value of savings. This is the notional risk associated with savings, that a lot of us don’t account for.

The Magic of Compounding –

Regarded as the 8th wonder of the world by Albert Einstein, compounding can generate exponential returns on your investment. Here’s a comparative chart to showcase the difference –

The above chart shows the interest earned on an investment of Rs. 5,00,000 at an interest rate of 10% p.a. over five years. Compounding over long periods gives such high returns, and that’s the main reason people are advised to start investing at an early age.

When to Save and When to Invest?

Saving and investing are both vital from a financial perspective, but their importance varies according to their time horizon.

  

   Short-Term Horizon –

The short-term horizon is, for example, up to three years. Now the period may vary according to your preferences, I have taken a standard.

Savings are preferred when you are looking at a short-term horizon. Savings are highly liquid, which means they can be utilized at a moment's notice, and being highly safe, there is little probability of losing money. Investing carries high risk, which sometimes leads to negative returns in the short-run, which is another reason saving should be preferred in the short-run. Being highly liquid also allows you to use your savings in an emergency, an option that is not exercisable when investing.

 Long-Term Horizon

A period exceeding three years can be termed as long-term.

Investing trump over savings in a long-term perspective. Investing gives exponential returns in the long-run and beats inflation by a hefty margin. Savings, on the other hand, fail to provide good returns in the longer period, and coupled with the rising inflation, the value of your money only deteriorates, making investing a preferred choice.

Savings – Pros and Cons

·       Pros –

1. Your money is safe –

Savings are the safest way to keep your money. Your savings deposits with banks are insured up to Rs. 5 Lacs by the Deposit Insurance and Credit Guarantee Corporation (DGIC). This means that if a bank fails, the government will step in to replace funds you may have lost.

2.  The Funds are Liquid –

Most of the investment instruments come with a definite period for investment and premature withdrawal from the investment can lead to lower returns or a reduction in your maturity amount. Savings, on the other hand, are highly liquid and can be withdrawn at any time for any purpose.

·       Cons –

1. Low Yield –

Savings may offer high liquidity and safety, but in exchange, they offer a paltry amount of interest compared to investment instruments. It is one of the least rewarding ways to save money, not even beating inflation at times.

2. No Tax Savings –

The money you save is saved from your after-tax income. You cannot claim any tax-deductions on the money you save, while there are some tax-saving financial instruments, that help decrease your tax liability.

Investing – Pros and Cons

·       Pros –

1. High Returns –

Investments, be it in any instrument, offers high returns to investors, beating inflation and savings returns, hands-down.

2. Diversification –

Investment offers you the opportunity to diversify among various financial instruments, which in turn helps to mitigate your risk and loss in case of a mishappening.

·       Cons –

1. High Risk –

The high returns come with a cost of higher risk. Although many people have made money by investing, a lot more have lost their money and even their livelihood in some cases. This risk has induced fear in the minds of young and newbie investors.

2. It is not highly liquid –

Some investment instruments are not very liquid and can take a longer time to sell. This lack of liquidity can be a con if you need to access your money quickly for use in other areas of your life.

Conclusion

Saving and investing, both, play an important part in your financial life, and a perfect combination of the two can help you become financially independent. I will be covering the various investment avenues in detail in my coming following blog posts, so check my blog every Sunday for any new posts.

Do comment on any queries that you have, and any feedback will be appreciated. Share the posts with your family and friends who are facing a dilemma of whether to invest or save. And do check out my other blog posts.