Savings vs Investments
Save or Invest
Before we embark on a journey towards financial independence, let us first understand the basics of savings and investments. A disciplined investor creates a balance between the two.
Saving is the process of parking hard cash in extremely safe and liquid securities. The primary aim should be capital preservation and the secondary goal getting some returns, if possible. This can include savings accounts and certificate of deposits among others.
Investing is the process of using money/capital to generate a safe and acceptable return over a time-period. An investment can include real estate, gold coins, stocks, mutual funds and small business to name a few.
Differentiate between saving and investment
- Savings are ideally smaller, for short-term goals in the near future like a vacation, emergency etc.
- Liquidity is high, giving ready access to cash when needed.
- There is typically no risk involved.
- You can earn interest on your savings.
- Investments involve putting money to work to create wealth for achieving long-term goals like child’s education, house etc..
- Liquidity is usually not easy when you invest money.
- Risk involved is usually high.
- Investments have a potential to yield higher returns, where investments appreciate over time.
How much should one save and invest?
Savings is the foundation to build your financial goals. Savings will provide you the capital to design your investments. The two basics that ideally need to be followed are:
- As a thumb rule, your savings should be enough to cover personal expenses like loan payments, insurance, utility bills etc. and any unforeseen expenses.
- Any specific purpose that will require a large corpus of fund in five – ten years should be investment driven. For eg. purchasing a home after say five years will require a steady investment objective today.
Define your goals
- While saving, your primary goal is to secure your money without losing any of its value. Though saving money preserves its nominal value, it’s opportunities to grow are limited.
- While investing, you give your assets the potential to grow over a time-period. Typically, you re-invest your interest, dividends and other capital gains. More often than not you are willing to take risks while investing your money. But with the appreciation in money, also comes the risk of losing money. Hence, keeping a long timeframe is usually recommended to recover from any decrease in value.
Here are the potential choices to be considered for savings:
- Savings accounts
- Money market accounts
- Certificate of deposits (CDs)
There are a host of investment options as well:
- Individual Securities such as stocks and bonds
- Pooled investments such as mutual funds
- Real Estate
How to make financial planning work for you
|Buy a car||You intend to buy a new car within a year.||Save|
|Down payment for a house||You would like to move into your new home in another 3-5 years||Save|
|Child’s higher education||Your toddler just started pre-school. Probably at least 15 years later you will need a lump sum amount||Invest|
|Have a comfortable retirement||You have just turned 30, you plan to retire at 60. 30 years of prudent saving will take you through||Invest|