Understanding the Basics of Saving and Investing
Does the terms saving and investing mean the same? This is a question on the back of the head for most of us. It is only natural that such doubts arise, because the two terms are so closely related. At best we can describe them as two sides of the same coin.
Therefore, it is better to understand the two concepts separately.
Savings: Tool for funding Immediate Future Payments : Savings are the small amount of money you put aside for future use. You do not spend them right away; instead reserve it for certain anticipated expense or as a contingency fund. Savings funds are highly liquid, that it can be used for any immediate payments. The money that you put in as savings, do not create any earnings. It is just a form of cash which can be easily accessed when needed.
For example, you keep some part of your income in your savings account for any emergency. If you want money to pay for an unexpected expense, say a hospital visit; you go to the ATM and withdraw the required money from your SB account. You can use cash quite easily from your savings account and notably the money residing in it does not earn much interest.
Besides, savings have low risk considering the fact that it only earns a small income. However, it must be understood that saving for a long term without much interest, is not financially a sound thing to do. This is because; over time the value of money decreases due of inflation.
Consider you have put aside a fixed amount of Rs. 10,000 from your income. Let us say the inflation rate is 5% per annum. This means that prices of goods rise by 5% every year, therefore, your purchasing power decreases. The next year your Rs. 10,000 cannot buy the same amount of goods as it can today. With 5% inflation your savings of Rs. 10,000 will be worth only Rs. 9,500 the next year.
Saving Options: There are many options for saving your money, to be used at times of need. One simple option is to keep some money at home. However, this is not safe and keeping huge amounts is rather, difficult.
A safer option is to deposit it in savings account. Though it is not as liquid as keeping money in your hands, it earns some interest. However, it is liquid than most other forms of deposits. With ATM facilities, debit cards and online banking, savings account has become more liquid than before.
If you want to save money for an expected future need, a short term fixed deposit is a good saving option. In a fixed deposit you keep aside a lump sum for a specific time period like 1 year, 2 years or 5 years. The money in FD earns an interest rate higher than a savings account.
Likewise, a recurring deposit is an ideal saving option for anyone who does not have any lump sum but can put aside small amounts at regular intervals, say starting of every month. The money grows to a lump sum in fixed period of time and you earn decent interest on that amount on maturity.
Investing: Make More Money with Savings : To understand investment better let us take the above example. You have a saving of Rs. 10,000 with you and the average rate of inflation is 5%. Now suppose you took your savings and buy some shares with it that gives you 8% return per annum.
After one year your Rs. 10,000 grows to Rs. 10,800 on 8% return. Adding the effect of the 5% inflation your purchasing power will be limited to Rs. 10,300. If you hadn’t invested it in shares your savings would have a purchasing power of only Rs. 9,500.
An important need of investment is to tide over the effects of inflation. In the above example inflation rate was 5% but rate of return for the asset was 8%. When our return is higher than inflation rate, the extra income will off set the loss due to inflation.
Therefore, investment essentially means making more money by buying income generating sources or income generating assets. Investments are mostly less liquid than savings, and are more risky. Once your money is invested in an income generating source, you cannot use it for paying any expenditure that easily. Investments are risky because markets are uncertain and the business in which we have invested might fail. If a loss occurs your investment is lost.
Investment Options: India offers good amount of investment options to individuals. One can invest in stocks, mutual funds, bonds, commodities, real estate and other financial instruments. You can also invest in business directly, and earn if it is successful.
After one year your Rs. 10,000 grows to Rs. 10,800 on 8% return. Adding the effect of the 5% inflation your purchasing power will be limited to Rs. 10,300. If you hadn’t invested it in shares your savings would have a purchasing power of only Rs. 9,500.
An important need of investment is to tide over the effects of inflation. In the above example inflation rate was 5% but rate of return for the asset was 8%. When our return is higher than inflation rate, the extra income will off set the loss due to inflation.
Therefore, investment essentially means making more money by buying income generating sources or income generating assets. Investments are mostly less liquid than savings, and are more risky. Once your money is invested in an income generating source, you cannot use it for paying any expenditure that easily. Investments are risky because markets are uncertain and the business in which we have invested might fail. If a loss occurs your investment is lost.
Investment Options: India offers good amount of investment options to individuals. One can invest in stocks, mutual funds, bonds, commodities, real estate and other financial instruments. You can also invest in business directly, and earn if it is successful.
Some Simple Differences between Saving and Investing
Now having the know-how of basics of saving and investing, let us see how different is saving from investing.
Getting Started: It is easy to start a saving. All you need is the willingness to save a part of your income by ‘paying yourself first’ and cutting down your expenditure. Opening a savings bank account is the most important step in beginning with saving habit, and it is the easiest one too.
Investments on the other hand need more attention and time. It must be noted here that, without saving there cannot be any investments. It is the money saved that is directed towards buying income generating assets.
Nowadays, you can begin investing even if your savings are small. Go for a systematic investment plan and invest in small amounts on a regular basis. In this way, you could make a significant investment over a period.
Time frame: Savings are usually for a period less than 5 years. Saving for a long period is actually a loss because the value of money decreases over time. Ideally savings should be associated with short term goals, like funding for an annual vacation or the down payment of your dream house.
Investments on the other hand works over a longer period to get the returns as agreed. The risks are heavier and choosing good income generating investments needs a lot of research. Usually, investments like mutual funds and stocks are longer than savings, more than 5 years taking about 15 to 20 years to grow your money astoundingly. Other investment options can extend up to 20 years or even 30 years. For example real estate and some government bonds (like the Railway Development bond, IRFC) have time periods exceeding 20 years to make remarkable profit.
However this doesn’t mean that Investments are always long term. We can do investments for a short time also. Suppose you buy shares of a company and say its share value rose dramatically within six months. Now you can sell your shares, cash your money and get out of that investment. This is a short time investment and you exit it after making profits.
Now having the know-how of basics of saving and investing, let us see how different is saving from investing.
Getting Started: It is easy to start a saving. All you need is the willingness to save a part of your income by ‘paying yourself first’ and cutting down your expenditure. Opening a savings bank account is the most important step in beginning with saving habit, and it is the easiest one too.
Investments on the other hand need more attention and time. It must be noted here that, without saving there cannot be any investments. It is the money saved that is directed towards buying income generating assets.
Nowadays, you can begin investing even if your savings are small. Go for a systematic investment plan and invest in small amounts on a regular basis. In this way, you could make a significant investment over a period.
Time frame: Savings are usually for a period less than 5 years. Saving for a long period is actually a loss because the value of money decreases over time. Ideally savings should be associated with short term goals, like funding for an annual vacation or the down payment of your dream house.
Investments on the other hand works over a longer period to get the returns as agreed. The risks are heavier and choosing good income generating investments needs a lot of research. Usually, investments like mutual funds and stocks are longer than savings, more than 5 years taking about 15 to 20 years to grow your money astoundingly. Other investment options can extend up to 20 years or even 30 years. For example real estate and some government bonds (like the Railway Development bond, IRFC) have time periods exceeding 20 years to make remarkable profit.
However this doesn’t mean that Investments are always long term. We can do investments for a short time also. Suppose you buy shares of a company and say its share value rose dramatically within six months. Now you can sell your shares, cash your money and get out of that investment. This is a short time investment and you exit it after making profits.
Various forms of Profit: By saving, you receive profit although small, as interest earned on the money deposited in the savings account or any other form of saving with the bank.
When you invest your money in a high return option, you get returns mainly in three different ways. It can take the form of interest or coupons on your long term investment options like fixed deposits or government bonds. Secondly as dividend, which is the return we receive from stocks of companies we have bought. The third is capital gain by cost appreciation of the value of the asset you invested in or the profit you get when invested in businesses. You can diversify investments to earn profit from all possible ways, thus supplementing income.
The difference in Returns earned: Mere savings cannot guarantee us any good returns. Even the best saving instruments offer an earning marginally higher than the prevailing inflation figures. A fixed deposit for 5 years earns an interest of 6-10% where as the inflation is hovering at 7-9%.
In order to make more money from what you have, you must think about starting an investment. Always opt for investments that agree to give compounded returns, because the return is the highest in this type of investment.
One must begin Investments as early as possible to enjoy the benefits at a later stage. For investments to be successful, your savings must be strong and consistent. Cultivate a habit of saving early in life. Without the foundation of saving, we cannot build the fort of Investment.
When you invest your money in a high return option, you get returns mainly in three different ways. It can take the form of interest or coupons on your long term investment options like fixed deposits or government bonds. Secondly as dividend, which is the return we receive from stocks of companies we have bought. The third is capital gain by cost appreciation of the value of the asset you invested in or the profit you get when invested in businesses. You can diversify investments to earn profit from all possible ways, thus supplementing income.
The difference in Returns earned: Mere savings cannot guarantee us any good returns. Even the best saving instruments offer an earning marginally higher than the prevailing inflation figures. A fixed deposit for 5 years earns an interest of 6-10% where as the inflation is hovering at 7-9%.
In order to make more money from what you have, you must think about starting an investment. Always opt for investments that agree to give compounded returns, because the return is the highest in this type of investment.
One must begin Investments as early as possible to enjoy the benefits at a later stage. For investments to be successful, your savings must be strong and consistent. Cultivate a habit of saving early in life. Without the foundation of saving, we cannot build the fort of Investment.