Learning the difference between savings and investment can be your step towards being a millionaire in future. Most of the people use them interchangeably but actually it should not be so.
Savings and investments are an important part of our finances. Both are useful when it comes to dealing with difficult financial situations or meeting major expenses, planned or unplanned.
Having sufficient savings and investments allow us to breath easy in our day- to-day life as far as finances are concerned. So it is essential that we are serious towards our savings and investments at the earliest before it is too late.
Before going for savings or an investment, make sure there is no confusion between both the concepts. Both are different things. Both are planned differently and both have different objectives.
It is a fact that most people consider them interchangeably. Doing so dilutes the very much objectives of both of them. This results in poor personal finance management. Lets have a look at the basic difference between savings and Investment.
Difference Between Savings and Investment
We can learn the difference between savings and investment better when we know clearly what is saving and investing. This is the step which makes you different from the crowd. This can be your first step towards being a millionaire in your life. This can be your life changing decision which you will realise after few years have passed and you are taking sips of coffee sitting leisurely with your loved ones.
But that is possible only if have understood the difference well and executed your plan wisely and with discipline.
Savings :- By definition, savings is what you are left with, after meeting all your essential and regular expenses out of your income. Adding up of savings regularly provides you with a pool of money which you can use to take care of unexpected sudden expense. The money in savings is available to you 24 hours a day or at the shortest possible notice when required. So savings act like a buffer to protect you in case of a financial emergency.
Returns wise, savings earn very small interest as they are routinely kept in simple savings bank account. The primary purpose of savings is to deal with emergency situations and not earn income on it. Most of the banks give a return of 3-4% on money kept in savings bank account. There is no risk to your cash left in bank account.
To make savings meaningful enough, it is important that you don’t go for unnecessary shopping and exhaust all your income in hope of getting next instalment of your income. Effort should be to strictly avoid the avoidable expenses. Ideally, you should create a habit of saving at least 25% of your income every time. Manage your expenses with the rest 75% of income. A popular quote by Investment legend Mr.Warren Buffet says –
“If you buy things you don’t need, soon you will have to sell things you need”
Investment :- An investment is the cash put in an asset class where it is expected to grow over a period of time. The purpose of investment is to make your money work to create more money. There are different asset classes like stocks, mutual funds, real estate, property, precious metals like gold etc. where you can invest your money.
Investments are associated with considerable risk because the prices of these assets are under markets control. Investment works on the principle that higher the risk you take higher the returns you may get. Investments are ideal only if you can give them sufficient time to absorb the volatility. It is usually less risky and more rewarding to invest for more than 10 years.
If you have a goal of becoming wealthy or meet a major expense like creating corpus for education of your children or for your own retirement, it is important that you look for investments. Spare some funds from your income and start investing in stocks or any asset class you like after doing basic research. Do it regularly and systematically.
Investments have the capability to give returns well above the traditional savings tools available in market. Investments also beat the inflation in longer run. Beating the inflation means you get returns which are able to cover the inflation rates too. Thus effective returns are more. This is in contrast to returns on savings or fixed income instruments.
Investments can yield returns of around 15% per annum over long term. Savings in fixed income tools can give returns maximum up to 8%. If we take inflation rates at 4%, we get effective returns of 15 – 4 = 11% for investment as compared to 4% (8 – 4 = 4) otherwise.
Savings vs Investing
These differences between savings and investments show that we can not take one as the substitute for the other. You can not use your investment to meet your emergency needs or expect your savings to create wealth for you. If you have sufficient savings, don’t undermine the importance of investing. On the other hand, if you don’t have enough liquid savings, avoid going for investing straightway.
Better way would be to first concentrate on creating a pool of cash equal to at least six months of your income in the form of savings.This is your Emergency Fund. You may use this cash for routine expenses in case of emergencies or if your income stops due to any reason. You can keep this cash as liquid money in your savings bank account or in some ultra short term Liquid Funds. The later offer better returns than savings bank account and can be redeemed within 24-48 hours if need arises.
After having pooled sufficient emergency fund, only then you should go for investments. Then see your money doing wonders for you in the form of investments. Choose good asset class according to your knowledge or guidance and keep your investment horizon long.
The idea of going for investment only after savings is to avoid liquidation of your investment in routine financial tightness. Not having a buffer of savings shall keep forcing you to exit out of your investments prematurely, sometimes in losses.