In this lesson, on the ‘differences between saving and investing,’ we will cover the true meaning of these two terms and their differences. We often use these two terms, interchangeably. Most people think they are investing, but in reality, they are saving. Indians are savers. Our saving lesson starts at an early stage with a piggy bank. Our parents give us money and ask to keep it in that ugly box. Thus, our saving starts even when we are not aware of the value of money.
The next financial step begins when we open a bank account. Our parents tell us to deposit the surplus money in it. However, the same thing continues for the rest of our lives. For example, we began to keep a certain percentage of our income in the savings account or do an FD and think that we are done. We don’t have to do anything more with our money.
Now the question arises whether that saved amount can help us to meet our future financial goals in life or not. Is it a good idea to keep all your money in your savings account or under the mattress? The answer is ‘no.’ Keeping all your money in a savings account is not a good idea. You should not stop at the first step. So, you have to move on and invest it. Let’s start.
What Is Saving?
When you deduct your expenses and liabilities from your income, the amount remained is called ‘savings.’ For example, spending on vegetables, ration, stationaries, education, fuel, gas, etc. is called expense. On the other hand, home loans, car loans, personal loans, different types of bills, or anything that you owe to others are called liabilities. Thus, we get the following formula for saving.
Saving = [Income – Expenses – Liability]
To take an example, suppose you get a monthly income of Rs 50,000. Your expenses make 50% of your income. That means you have to deduct Rs 25,000 from it. Further, Rs 10,000 goes towards your loan EMI. Thus, you can say that you have saved Rs 15,000 [50,000 – 25,000 – 10,000]. That’s simple math.
Further, if you keep that saved amount in your savings account, locker, fixed deposits, liquid funds, or just cash-in-hand, you can call it saving, not investing because the returns are the same as the rate of inflation or below it.
However, saving is essential. It is the first step towards your wealth creation. It protects your money. Thus, the primary purpose of saving is the safety of your capital. Further, it will help you meet your daily expenses, short-term goals, obligations, and unforeseen expenses like emergencies. Therefore, it is good to save at least six months of income in liquid assets, e.g., savings account or fixed deposits. However, I would recommend you save at least your one-year income. It will help you to absorb the financial shocks during a shutdown or jobless.
Thus, saving means:
- You are keeping aside some money every time you get your income in physical locations, e.g., piggy bank, under the mattress, or inside the table drawer.
- You are keeping the money in your savings account or fixed deposits where returns are either the same or below the inflation rate.
- Savings account, current account, bank and postal fixed deposits, recurring deposits, liquid funds, overnight funds, insurance products, etc. are some of the saving instruments.
What Is Investing?
Once you have saved money equal to your annual income, plus your short term goals, and emergencies, you need to start investing. Unlike saving, the primary purpose of investing is to grow your money faster than inflation. So, investing is all about capital growth and wealth creation. Thus, it is generally a medium to long term activity. By medium term, I mean a time-horizon of 3-5 years. Similarly, the long term means a time horizon of five years or more.
Thus, you should save for your short term goals but invest for your medium to long term goals. Investing for short term goals is not advised as most asset classes have some sort of volatility. Volatility means the price fluctuation. As you might have seen, the price of a share goes up and down daily. The price of gold also fluctuates daily, along with other commodities. However, in the long run, these price fluctuations can become an advantage.
In investing, you put your capital at risk. You should remember that you can lose some part of your money or all of it during the course. However, there are techniques to mitigate the risk that we will cover later. You can minimize the risk and maximize your return by following a few simple methods that you have to learn before you start investing. Investing is like driving a car. It is risky to drive a vehicle because, on average, 3700 people die every day on road accidents globally. However, it can help you safely reach your destination if you learn driving and follow certain principles like wearing your seatbelt. Further, it sounds odd when one says he or she does not like to drive a car because it is risky. The same is true with investing.
The difference between saving and investing
|LIQUIDITY||YES||BOTH YES AND NO|
|RISK||LOW RISK||MEDIUM TO HIGH RISK|
|RETURN||LOW RETURN||MEDIUM TO HIGH RETURN|
|ABILITY TO BEAT INFLATION||NO||YES|
|RETURNS ARE GUARNTEED||YES||NO|
|INVESTMENT TIME-HORIZON||SHORT TERM||MEDIUM TO LON TERM|
|PURPOSE||SAFETY OF THE CAPITAL||CAPITAL GROWTH|
|SPECIAL SKILL IS REQUIRED||NO||YES|
|EXAMPLES||SAVINGS ACCOUNT, FIXED DEPOSITS, LIQUID FUNDS, ETC.||REAL ESTATE, STOCKS, GOLD, ETC.|
Liquidity means the ability to turn assets into cash without any negative impact on the profit. Saving provides you liquidity, but investing does not. For example, you can redeem your money from your savings account or liquid fund whenever you wish without impacting profit. However, it is not valid with real estate. You may not find a buyer in the short term or have to book loss even if you get one. Thus, you should only invest that money that you don’t require for three to five years.
Next comes risk. Saving is mostly risk-free, but investing comes with some inherent risk. For example, your money at banks is protected up to Rs 5 Lakh by DICGC (Deposit Insurance and Credit Guarantee Corporation). However, if you keep more than Rs 5 Lakh in a bank (across the branches) either in your savings account, fixed deposits, or recurring deposits, that additional amount is not covered. Therefore, it is wise to restrict yourself from depositing more than Rs 5 Lakh in a particular bank. However, investing is not risk-free. Your money in real estate, gold, shares of a company, etc. can give you a negative return. To minimize the risk, you can keep it invested for the long term after detailed analysis.
Saving comes with low risk and low return. Generally, in saving, we get a return that is equal to the rate of inflation or lower than it. Thus, the purchasing power of our money goes down with each passing year. However, getting a return above the rate of inflation is easy in investing. One thing to remember here is that you may not beat inflation each year, but you can do it over a long period. For example, Nifty or Sensex can give you negative returns in the short term, but it can deliver a profit of 12% or more over a more extended period. Most importantly, the returns are not guaranteed.
Many people think that real estate investing is the safest option. They claim they double their money in just four years. I don’t disagree with them. But it does not continue for long. You can double your money in only four years with an 18% CAGR (Compound Annual Growth Rate). It is easy to get such returns in other investment options also. Further, real estate, like other investment options has its cycles. It also follows the simple principle of economy ‘demand and supply’.
Saving is not tax-friendly. Your bank will deduct TDS (Tax Deducted at Source). Further, your income from saving will be added to your total income and have to pay it according to your tax slab. If you are in a high tax bracket, a significant chunk of your profit will go into tax compilation. However, investing comes with two tax-forms, STCG (Short Term Capital Gain) and LTCG (Long Term Capital Gain). They are not linked to your tax-slab.
Volatility means price fluctuation. You can see the graph of Nifty or Sensex and observe that the price has increased and decreased over a specified period. They are not constant and goes up and down. The same happens with the price of gold. However, in the long term, these asset classes give you a decent return.
Moreover, intelligent investors take advantage of this volatility and make substantial money. Thus, you should not be worried about volatility but learn how to take advantage of it. However, most saving instruments are not volatile.
As we have already discussed, if you have a short term financial goal, you should choose saving over investing. But, long term goals like retirement planning cannot be achieved by mere saving. You must have to invest in retaining the purchasing power of your money. Once you save an amount equal to your annual income and meet your short term goals and emergencies, you should start investing.
However, you have to learn some basic principles of investing, human emotions, behavioral finance, balance sheets, profit-loss statements, cash flow statements, tax implications, the science of supply and demand, cycles, and many more if you want to be a successful investor. Further, acquiring these skills and knowledge does not mean that you will be a successful investor. Your attitude, outlook, critical thinking, emotions, patience, etc. also play an essential role in investing. However, saving does not require any of the qualities mentioned above.
Finally, the primary purpose of saving is capital protection. However, investing is creating wealth or growing your capital.
Final Thought On The Differences Of Saving And Investing
Saving is the first step and investing the next. Both are necessary as we have both short term as well as long term financial goals in our life. Mixing these two terms or using them interchangeably can cause inconvenience in the future. Most people save but never invest in their life. Others invest even their emergency fund and have financial crunch during a crucial time. Therefore, sticking with one is not a wise idea. You have to complete the first step and then step into the next level. That is the core principle of life.
I have tried to make things clear for you. However, I need your comments, suggestions, and remarks to create more value in your financial life. Don’t forget to share it with your loved ones.
Thanks and reagrds,