Have you ever been confused about the difference between saving and investing? On one hand, investing money at the right place can help you in the process of wealth creation. On the other hand, investors advise new players to invest only that portion of money that they are left with after setting their emergency funds aside. More confused than before?
Savings and Investment are very different and how you perceive this difference can make a big difference in how successful you are as an investor.
Essentially, both savings and investments hold monetary value that exists within financial instruments. Cash, fixed deposits, recurring deposits, etc are some of the common instruments which are used for the purpose of savings. On the other hand, instruments like stocks, bonds, equity, ULIPs and mutual funds are investment instruments. So how do they differ, and why should it matter to you? Let’s look at some key differences between saving and investing in detail, to answer that question.
Objective: This is the sharpest difference between savings and investments. In the context of investments, savings are made to generate and prepare capital for investments. That’s why it is recommended to not invest all of your savings. Savings are usually short term and anyone can save without having to do much research.
Investments, on the other hand, are made to achieve bigger goals like wealth creation, buying a house, funding education, and so on. Investments can often require long term commitments and market research. While savings will go down only in rare circumstances, investments can potentially go both ways, if not made with due diligence and market research.
Liquidity: Savings instruments are usually associated with high liquidity. Therefore, they provide you with ready access to cash as and when needed. Investments, on the other hand, can have varying degrees of liquidity across various instruments. For example, growth stocks are high liquidity instruments while penny stocks are low liquidity instruments.
That is why your emergency funds should never be invested.
Risk: Savings are usually associated with very low or negligible risk, while investments can be made in both high risk instruments and low risk instruments. Instruments like FDs and bank account balance will never show a decline – you will always earn steady interest on them. However, investments can show a downward movement in accordance with a company’s performance, the market conditions at that time, performance of other industries, and other economic and financial factors. That is why, investments are usually correlated with some risk while savings are associated with “zero risk”.
Returns: This is another crucial point of difference. You can usually earn only a fixed and steady amount of interest on your savings. Consider FDs for example, where you can earn 4-8% of steady interest on your principal amount over a year. However, these returns often work only to preserve the value of the amount directed towards savings due to factors like inflation. That’s why savings cannot be used to fuel other expenses.
On the other hand, investments have the potential to yield much higher returns if they show an upward movement. As mentioned earlier, investments can be associated with high risk too.
Knowing these differences, you can probably put things into perspective and accurately compare savings vs investments. While savings constitute the safety net that you can fall back on in times of emergency, investments do not. So how do you channel your money appropriately? The answer will be different for every person. And that’s because the answer depends on your goals and your financial situation.
For example, if you are in your twenties and have a steady income from a job – in such a scenario, you can invest all the surplus money that you have, after having accounted for your outstanding loans, your expenses, bills and emergency funds. On the other hand, in a scenario where you have a family that depends on you, your emergency funds and your savings will have to be substantially bigger, before you can direct that money to the equity.
Savings vs investments vary as much in principle, as in practice. For example, it is possible to have a substantial corpus of savings in your account but still not be able to meet your long term goals. While savings will provide financial security, you may not be able to meet bigger and long term requirements like your child’s college education with just your savings. That is why, savings are not a substitute for investments, just as investments are not a substitute for savings. This should have become more clear to investors after the coronavirus pandemic hit the markets. That is why, smart investors advise young investors never to confound their savings with investments.