Personal Finance: Why investment should be different from savings?

Investment ‘Savings’ and ‘investment’ are two words that are easily used interchangeably by the common man. However, there is a huge difference between the two and understanding this can make your finances work much more efficiently. The main aim of ‘savings’ is preserving capital, while that of ‘investment’ is growing capital. Both have an important role to play in every individual’s financial plan for a comfortable and secure life.


Investment Vs Savings

When a child enjoys a part of the chocolate and ‘saves’ the rest for later, that’s how soon ‘savings’ makes a way in an individual’s life! As adults, the meaning of savings turns out to be different for different individuals. While for some people savings may mean having money in a bank account, to others it may mean holding on to cash stacked away somewhere in the house. However, technically, savings mean holding on to your income and spending less today, so that you have more to spend tomorrow! Therefore, the money held in banks and/or the cash stacked up somewhere can be counted as savings.

Investment on the other hand, is putting in a part of your income in certain financial instruments like fixed deposits, stock market, mutual funds, insurance policies or even property, which help grow your money over time. Investments could be – short term, medium term or long term in nature depending on the time period you hold the investments.

Simply put – the main aim of ‘savings’ is preserving capital, while that of ‘investment’ is growing capital. Both have an important role to play in every individual’s financial plan for a comfortable and secure life.

Objectives of Financial Planning

Anyone who believes that only saving a good amount regularly can suffice for a decent lifestyle, is mistaken. Savings alone will not be able to meet your needs with rising inflation and lifestyle changes. Also, an unexpected emergency can easily drain out all savings, leaving you empty-handed.

Similarly, making investments without having sufficient savings can mess up with the objectives of investment planning. Only investment and no savings would mean insufficient liquidity for emergencies or immediate needs.

Therefore, while savings can be a part of your financial planning i.e. money kept aside for an emergency or a future purchase, investment can be the vehicle to grow your money over the long term.

It takes both ‘savings’ and ‘investment’ to make any financial plan a success. The objectives of financial planning are:

  • Maintaining the required balance between inflow and outflow of money
  • Forming a capital structure based on an individual’s present & future financial requirements
  • Making a monetary plan with set finances for not just survival & emergencies, but also growth over time
  • Reduce uncertainties brought by changes in the economy or any personal emergency and shield your finances

The difference between investment and savings

There are certain parameters that bring out the difference between savings and investment and emphasize why the two should be treated differently.

  • Risk:
    Savings – Value of money in banks or cash in hand remains same till you spend it. Therefore, the risk of losing your principle amount is low (or even negligible) in case of savings.
    Investment – Risk component in an investment is relatively high. The degree of risk shall further vary depending on the investment instrument you choose. Putting money in a fixed deposit, Public Provident Fund (PPF) or National Savings Certificates (NSCs) has low risk compared to investments in the stock market and/or mutual funds.
  • Returns:
    Savings– Since the risk in savings is low, so are the returns. In fact, if savings are in the form of stacked cash only, then the returns are obviously zero!
    Investments – Investments give comparatively higher returns. However, the rate of return depends on the nature of investment instrument you choose. Quality investments have the potential to yield much higher returns over a long term, as compared to savings.
  • Liquidity:
    Savings – One of the biggest advantages of savings is that it is highly liquid. Therefore, it comes very handy in case of emergencies or unplanned needs like a repair, an emergency travel, etc. However, one cannot ignore the fact that easily accessible money is also easy to spend.
    Investments – Investments are relatively less liquid. Some investments like open-ended equity mutual funds may allow redemption, but they come with terms & conditions, and of course, taxes!
  • Time:
    Savings This works well for emergencies and small short term (1-3 years) financial objectives. Be it a vacation, house deposit, a home appliance or a mobile – money accumulated as savings can suffice such needs.
    Investment This can be for short, medium or long terms. However, for larger financial goals, long term investments (at least 5-10 years) work best. Investments can help you grow your money for financial goals like your child’s education or wedding, a comfortable retired life.

Investment Vs Savings: How much should be put towards each?

Both savings and investment planning have different objectives for different time periods. And good financial planning can bring both together to create the most appropriate capital structure for individual needs and goals.

Experts recommend saving at least 10% of your monthly income. Also, as a part of savings, an emergency fund is a must for uncertain times. You can open a new bank account dedicated to this. As per the general rule, an emergency fund should have enough money to suffice for your usual lifestyle for three months. The only thing that can take some precedence over creating an emergency fund is paying off debts, especially the ones that attract more interest. This is because debts can be huge dampeners for financial goals and should ideally be done with as soon as possible.

After savings, should come investments. Initial investments can be in insurance, especially a health insurance as it can shield your savings in difficult times.

Investments are broadly defined based on the time period:

  • Short-term investments – These investments are ideal for goals with 3-years horizon. The ideal places to park money for this can be a fixed deposit, bonds and debt mutual funds.
  • Medium-term and long-term investments – For medium term, the time period is between 3 and 7 years, while for long-term, it is over 7 years. In these cases, investments in PPF, NSCs, quality shares in the stock market, mutual funds can help you grow your capital. The choice of investment here will mainly depend on the risk appetite and financial goals.

Investment Vs Savings – In a nutshell

Savings Investment
For short term only Can be for short, medium and long term
Low risk, low (or no) returns Relatively higher risk, higher return
High liquidity Low liquidity
Attracts no major taxes Attracts taxes
Accumulates (and protects) capital Grows capital

Conclusion

Your savings and investments should be able to match your short term needs, as well as work towards fulfilling your medium and long term financial goals. It should also keep you well-prepared for uncertain times.

Saving accumulates wealth, while investment grows wealth. And a financially fulfilling life needs both – accumulation and growth. Merging the two is neither possible nor advisable.

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