Exploring the key differences between investing and savings

In India, like in many other parts of the world, investing and savings are often used interchangeably. However, there is a clear distinction between the two concepts. This article aims to explore differences between investment and savings, and how each approach has its own merits and applications based on your financial situation and objectives.

Table of contents

What is saving?
Some key characteristics of saving
Pros and Cons of Saving
What is investing?
Some key characteristics of investing
Pros and Cons of Investing
When to invest vs save?

What is Saving?

Saving refers to setting aside a portion of your earned income in a bank account, provident fund, or other saving instruments with the aim of accumulating a pool of funds over time that can be used for future needs or emergencies. The primary goal of saving is protection of the invested capital.

Some key characteristics of saving

Capital is stored in relatively stable instruments like savings accounts, with minimal risk of loss of principal.
Returns are usually fixed and pre-determined based on interest rate offered by the bank/institution. Returns may sometimes fail to beat inflation over long periods.
Easy access to funds with flexibility to withdraw money as needed for short term goals.
Not ideally suited for long-term wealth creation goals like retirement due to inflation risk over many years.

Thus, savings may be better suited for short to medium term financial goals within 5-10 years where capital preservation is important.

Pros and cons of saving instruments

Pros of Saving

Financial security: Savings provide a safety net for emergencies, such as unexpected medical expenses, job loss, or urgent repairs. Having readily accessible funds can prevent financial stress during unforeseen circumstances.
Low risk: Savings are typically held in stable instruments like savings accounts, fixed deposits, or government-backed schemes. These options carry minimal risk of losing the principal amount, making them a secure choice.
Liquidity and accessibility: Savings accounts and similar instruments allow easy access to funds, making them ideal for short-term financial goals or immediate cash requirements.
Discipline in financial planning: Saving helps inculcate financial discipline by encouraging individuals to set aside money regularly for specific goals, such as purchasing a home, funding education, or planning vacations.
Foundation for investments: Savings act as the groundwork for investments. Without adequate savings, it becomes challenging to allocate funds toward higher-return investment opportunities.
Peace of mind: Knowing you have money set aside provides psychological comfort and reduces anxiety about future uncertainties.

Cons of Saving

Low returns: Savings instruments typically provide lower return potential compared to investments like stocks or mutual funds. The interest rates may fail to outpace inflation, eroding the purchasing power of your money over time.
Inflation risk: Over time, inflation can diminish the value of savings. For example, while your savings remain stable in nominal terms, their real value may decrease due to rising prices.
Opportunity cost: By focusing solely on saving and avoiding investments, you may miss out on opportunities to potentially grow your wealth through avenues such as equities or real estate, which offer higher return potential in the long term.
Psychological barriers: Overemphasis on saving can create a reluctance to spend, leading to overly frugal habits that may impact quality of life or relationships.
Fees and requirements: Some savings accounts come with minimum balance requirements or maintenance fees that can eat into your corpus if not managed properly.

What is Investing?

Investing refers to allocating funds into instruments that have the potential to generate wealth over the long term like stocks, mutual fund investments, real estate, etc. The primary goal of investing is to earn relatively better returns than simple savings instruments. Investing can prove to be a good way to put your money to work and build wealth in the long run. It can also help you generate inflation-beating returns. The greater growth potential of investing is due to the power of compounding and the risk-return tradeoff.

Some key characteristics of investing

Due to fluctuations in share markets or property prices, higher risk is involved as compared to savings.
Returns are not fixed or guaranteed but have potential for better growth than savings over long periods.
Not as liquid as savings. May take time to liquidate investments if there’s a need to access funds before maturity.
Ideally suited for long term objectives like retirement, child's education etc., where one can ride out short term volatility.

Thus, investing helps combat inflation and can achieve long term objectives, unlike saving, which only provides inflation adjusted returns at best.

Pros and cons of investing

Before considering investments, it's important to weigh the potential benefits against the possible downsides.

Some of the key pros of investing include the below.

Long-term growth potential - Investing gives your money the ability to grow faster over time compared to keeping it in savings accounts.
Diversification - Investing allows you to spread your money across different assets like stocks, bonds, real estate, which mitigates risk compared to having all your money in one place.
Passive income - Investments such as dividend-yielding stocks and real estate can generate passive income streams.
Inflation-beating returns - Investment returns can potentially outpace inflation over the long run, allowing the net value of your funds to increase.
Compounding growth - Reinvesting investment gains can accelerate growth exponentially over long periods through the power of compounding.

Cons of savings

Market volatility - Stock and bond prices can fluctuate, sometimes significantly, especially in the short term. Moreover, returns are not guaranteed.
Lower liquidity - Some investments like real estate are less liquid compared to stocks and cannot be converted to cash quickly.
Fees/costs - Investment expenses like brokerage fees, mutual fund expense ratios directly reduce net returns.
Speculative bubbles - Periods of excessive valuation among certain assets can lead to sudden crashes when bubbles burst.

When to Invest vs Save?

It is generally better to save for goals that may take 1-3 years to achieve. This includes short-term goals like planning an annual vacation. On the other hand, goals that are 3 years or longer away are suited for investing. Investing provides a relatively better return potential over time to beat inflation when the time horizon is 3 years or longer.

Conclusion

While saving and investing both aim to achieve financial goals, their approach differs significantly given their distinct risk-return tradeoffs. Understanding investment vs saving differences is critical to formulate the right savings and investment strategy tailored to your unique needs and time horizon for various life goals. A combination of both is usually required across different asset classes and time periods. With discipline and diligence, you can make the most of both for a better financial future.

FAQs:

Is it better to save or invest a lumpsum amount?

If the amount is large and the goal is more than 3-5 years away, it may be better to invest it for a relatively higher return potential through systematic investment in mutual funds. Else, savings is better to park lumpsums within 3 years where stability of capital is priority.

How can I get the benefits of both saving and investing?

Maintain separate accounts – one for short term savings goals and another for long term SIPs in mutual funds or other investments. Try growing your investment corpus steadily while protecting savings for cashflow needs.

What is the difference between fixed and recurring deposits?

Fixed deposits have a fixed tenure while recurring deposits accept periodic installments over a period. Both offer almost similar rates, good for parking short term money. However, FDs have no step-up in interest rates for longer tenures unlike RDs where interest rates increase for longer installment periods.

Mutual Fund investments are subject to market risks; read all scheme-related documents carefully.
This document should not be treated as an endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.