Savings and investment are among the most fundamental concepts involved in financial planning. And while they may appear fairly similar to each other, there’s quite a bit of difference between savings and investment. If you’re new to the world of financial planning and investing, the line between these two practices may appear blurred. It’s essential, then, to get to the fundamentals to help you understand the answer to the question “what is the difference between saving and investing?”
What is the meaning of savings?
In essence, savings refers to the amount of your disposable income that’s left over after you’ve paid for all your regular and infrequent expenses. These expenses include all kinds of consumer expenditure including rent, utilities, the cost of provisions, medical expenses, travel costs, EMIs for loans, and other payments you need to make.
The amount that’s left to your credit after these costs have been met is classified as your savings. The money that you’ve thus saved can be held as cash or deposited in a savings bank account. While your savings cannot grow exponentially by themselves, you can earn a basic rate of interest on the amount in your savings bank account.
What is an investment?
Economically speaking, investment is the act of purchasing an asset that you don’t intend to consume or use today. Rather, the goal of investment is to create wealth by allowing the capital invested to appreciate over time. The goal of investing can vary from one investor to another, and it could be to protect earnings, to make money grow, or to earn a steady income.
Investments can be long-term products or short-term instruments. Depending on your financial plan and your life goals, you can choose the kind of investments to park your funds in. Some examples of investments include real estate, direct equity, Unit Linked Insurance Plans (ULIPs), mutual funds, and gold.
Saving vs. investing: An overview
Saving and investing both come with their own set of advantages and disadvantages. For instance, if you decide to only save your money without investing it in any kind of assets, the upside is that your money remains safe and protected, without any risk of being eroded. You can also use your savings to meet set goals on a timeline. On the downside, your money is not hedged against inflation, so you could lose your purchasing power over time.
When it comes to investing, the primary benefit is that you stand to gain potentially higher returns over time, due to the power of compounding. As a result, you can reach your short-term and long-term goals faster. Many investments also come with tax-saving advantages. However, on the flip side, your investments also run the risk of eroding in value in case of poor market movements.
What is the difference between saving and investing?
There are many points of difference between savings and investment. To understand the contest of saving vs. investing better, let’s take a closer look at these points.
Savings are generally considered to be much safer than investments, particularly if you’ve deposited your savings in a trusted bank. With investments, there’s always the risk of your capital decreasing if the market does not move favorably. Savings are not exposed to this kind of risk, but they are not immune to the risk of inflation.
Most banks offer nominal rates of interest on your savings. However, the returns obtained by investing your money are generally much higher, because your money has a longer period of time to grow. The power of compounding helps money that is invested grow exponentially. Some investments may grow at a faster rate than others, depending on the interest rates and market conditions.
Savings are generally ideal for the short term, since you can set a finite target and save up to that limit to meet short-term goals like purchasing a new laptop or taking an extended vacation. Investments, on the other hand, are typically for the long term. Some investments like Public Provident Fund (PPF) have a duration extending up to 15 years. Other alternatives can remain untouched for 20 years or more.
Since your savings are more liquid than investments, you can easily access them in case of any emergency. In most cases, you only need to withdraw your savings from a bank or use cash already present in your hand. Investments are not as liquid, and depending on the kind of product, you may sometimes even have to incur a penalty to withdraw money you’ve invested.
So, when it comes to saving vs. investing, which should you choose? Ideally, you need to have a mix of both, so you can meet your short-term goals and your long-term objectives. Balancing the two also ensures that you have enough money accessible to spend today, while also making it possible for you to let a part of your money grow, so you can have a secure future.