Savings and investing are two terms that are often used interchangeably. However in reality, the terms are distinctly apart. When it comes to your money, it pays to understand the difference between the two. Should you be saving or investing? What really needs to be done?
Lets’ go by Definition First
Meaning of Savings: From the income that you make every month, you incur essential expenses and make payments towards house rent, food and leisure, school expenses, other provision bills etc…What remains in your hand after your expenditure is your savings. So technically speaking savings is the difference between your income and your expenses.
Meaning of Investing: When you put your savings into a financial product, that is capable of generating some returns for you, it is known as investing. By investing you would be using your money to purchase shares, gold, real estate, bonds or fixed deposits, with a sole aim of further generating wealth out of it.
Characteristic difference between Savings and Investing
Savings is a very passive way of maintaining your money. An age old practice of saving money has been stacking notes in kitchen jars and containers. They are typically meant to be there to cater towards emergency expenses. They would not have to be monitored and would always be present when required. With nil risk and high liquidity, saving money is a simple way of managing money as it would seldom be affected by market or economic instability. But do remember, though it may seem to be a safe bet, saving money has no scope to generate wealth and is really not suited to meet long term financial goals.
On the contrary, investing is a far more active mechanism of keeping money that requires regular monitoring and evaluation. By investing, you give your money an opportunity to grow. This wealth generated would help you meet long term goals of retirement, building your home or children’s education/ marriage.
In every investment you do bear a certain element of risk. Fluctuation in market, price and interest movements could impact the performance of your investment, thus the returns too. The higher the expected return from your return, higher is the risk you bear.
Investments vary in their degree of liquidity. Getting access to it may not be immediate and range from 1-2 days to a week. Assets such as real estate may sometime take a month or so complete the entire transaction.
Saving versus Investing- What should you do?
Both saving and investing does help meet your goals. What sets them apart is in the nature of the goals.
Cash in your savings kitty may often seem to be a safe deal, with easy liquidity and minimal risk involved. However what needs to be borne in mind is, the impact inflation would have on its value. Inflation reduces the purchasing power of money over time. So unless you invest your money at a rate of return higher than the rate of inflation, it may not really help you achieve financial goals.
Thus, saving is suitable:
- For small sums of money intended to meet immediate to short term goals of a few months such as a holiday
- For low risk emergency cash at hand such as quick expenses and purchases.
If you are investing your money, you must be prepared to bear a certain degree of risk. Nevertheless, despite the risk, you are giving your savings an opportunity to grow and beat the negative impact of inflation. You would be able to meet the financial demands of your goals far effectively.
When you embark on your journey of investing clearly define your financial goals and timeline as to when you want them fulfilled. Being aware of your goals gives you an idea of what exactly you would be investing for.
You should invest:
- If you want to give your money a chance to grow.
- Want your savings to earn returns
- To beat the impact of inflation
- Have financial goals to be fulfilled, long term or short term.
The Compounding Effect in Investing
The reason why investing proves to be beneficial in fulfilling long term goals, is because of the power of compounding. Compounding ploughs back any earnings from an investment back into it. It lets you earn on the principal as well as on the accrued interest, thus making your investment grow exponentially over time. Thus, if you are saving for financial goals start early and invest. It would mean you invest lesser, and let compounding work its way on your money.