Saving vs. Investing: Key Differences & Which One’s Better?
Saving vs. Investing: While saving and investing are often used interchangeably, they are two completely different processes.
Saving refers to keeping aside a portion of your income for your short-term goals, and emergency needs. Investing, on the other hand, refers to the process of growing your money, by putting it to work in different appreciating assets.
Of course, the above definitions are vastly incomplete and insufficient!
Both saving and investing are crucial elements of an effective personal financial plan.
Saving is often considered to be the precursor of investing. Hence it is good to know how they complement each other, and how you can balance between the two.
Although questions like, what is saving? what is investing? and how are they different? might sound insignificant, but these are fundamental questions one should ask before making a financial plan.
And not having a financial plan, is arguably the biggest personal finance mistake one could make!
So, let’s address the elephant in the room: Saving vs. Investing and Which one’s better?
What is Saving?
This might seem like a basic question, “What is Saving?”, and you are expected to know the answer. But it is only when you ask such fundamental questions, you understand the nuances of personal finance.
Saving and savings are two facets of the same phenomenon. While ‘saving’ is the process, ‘savings’ is the outcome.
These definitions are way too simple to comprehend, so let’s have our own versions.
Saving, as a process, is often considered to be the precursor of investing. You cannot invest if you are not able to save anything.
In that sense, ‘Saving’ is the process of keeping aside a portion of your regular earnings, over and above your expenses, and ‘Savings’ is that part of your income, which you keep aside to spend at a future date.
Here’s a famous equation you must have come across:-
Income – Expenses = Savings
We arrive at a more accurate version of this equation if we take our liabilities into account:
Income- Expenses- Liabilities = Savings
Income is what you earn. Expenses cover what you spend on needs, wants, and luxuries. And, liabilities account for your debt repayment, EMIs, etc.
What’s left, is your savings!
Where to Keep your Savings?
The process of saving usually involves keeping aside a portion of your income into low-risk instruments, like savings accounts offered by banks.
This is because savings are usually meant to cover your short-term goals and emergencies. Now, you don’t want your emergency fund to be put into something like cryptocurrencies, where volatility and high risk are the norms.
You should put your savings into low-risk instruments that have the following characteristics:
- Low risk (and therefore, understandably low returns!),
- Guaranteed returns (or at least the risk of losing your money is very low),
- Beats inflation (ideally!),
- Safe and secured,
- Highly liquid, and
- Hassle-free withdrawal.
Putting your savings in piggy banks, or stashing them under the mattress with the perception that you’re ‘saving’, is stupidity at its best!
You should be able to earn a stable interest on your savings. The interest rate here should ideally be higher than the inflation rate, or at least at par with inflation. Otherwise, you’ll lose the purchasing power of your savings over time.
Here are some of the best places to put your savings:
If liquidity and safety are you’re top priority ‘Savings Account’ offered by banks is the best option for you. You can withdraw your money at very short notice. The rate of interest, however, is usually below inflation rates! At max, you can expect 4-5% interest rates.
If you’re saving for short-term goals, and you have around a year at hand then you can go for Fixed Deposits, short-term debt funds, Post Office Term Deposits, etc. There are many fixed-income investment options available for a maturity period of 3 months to 1 year.
Why is it important to save your money?
While most of the reasons vary from person to person, there are some obvious reasons as well.
- Goal-Oriented Savings
People usually save for their personal and professional goals. Now, this can range from saving for a birthday party to saving for education.
As a rule of thumb, saving is usually done to cover short-term goals, while we prefer investing for our long-term goals.
Say for example, if you are planning a vacation next month, investing your money in the stock market may not be a good idea due to high volatility, instead, you might want to put your money in a relatively stable and liquid instrument.
On the other hand, if you’re saving for your retirement, in that case investing for the long term will be the best option.
- Saving for Emergencies
One of the major reasons, why you should save your money is to be able to cover emergencies.
Human life is full of uncertainties and we cannot predict what is going to happen tomorrow. Now, god forbid, if something unfortunate happens to you or your family, you need to be well prepared to face such challenges, both mentally and financially.
Insurance policies make the foundation of your emergency fund! but it is not the only thing.
There are a bunch of insurance policies available these days in the market, for a very low premium. As your age goes up, the premium goes up, therefore, starting early is a good idea. You will be able to get low premium options if you take an insurance plan at a young age.
Getting health insurance, and life insurance coverage are some of the earliest footsteps toward financial independence.
In his Foreword to Saurabh Mukherjea, Rakhsit Ranjan and Pranab Uniyal’s book ‘Coffee Can Investing: The Low-Risk Road to Stupendous Wealth’, CEO of Ambit Capital, Ashok Wadhwa wrote:
Thus, your “rainy-day corpus” should be easily accessible as well.
Therefore, keep aside a good portion of your emergency fund in a savings account (as I mentioned earlier), from where you can immediately withdraw the money.
If you are still not convinced why you should save your money, here are a few more reasons:
- For your peace of mind!
- Sense of security, and self-confidence.
- Better future prospects.
- Ability to deal with layoffs and unemployment.
- Feeling of freedom.
What is Investing?
Investing refers to the process of letting your money grow over time, by putting it to work into different asset classes that appreciate with time.
There are only two broad ways to make money:
- You work for money.
- Your money works for you!
Investing allows you to make money, without putting in all the active work. Your money does the job for you, giving you a passive income source.
Now money works in two ways:
- Interest or Dividend Income
Interest or Dividend Income
In a financial system, there are two broad categories of people:
- Savers/Lenders: Those who earn more than they spend.
- Borrowers: Those who spend more than they earn.
The job of a financial system is to transfer the money (a scarce resource!) from the savers to the borrowers. This is done in two ways:
- Through financial intermediaries:
Financial institutions like banks and fund houses take the money from the savers and give it to the borrowers. This way savers can indirectly provide funds to the borrowers.
In return, the savers expect to get their principal amount back after a certain period, along with a good interest income.
- Through financial markets:
Savers can directly lend their money to the borrowers in the financial markets. For example, in the stock markets, one can directly give money to a company in need of it.
In return, the savers earn a recurring income from the company’s profits, called dividend income.
Interest or dividend income is considered a way of earning a stable and regular income.
Appreciation: Increase in Value Over Time
The second way to make your money work for you is by buying things that are likely to increase in value with time.
For example, you buy a piece of land with the hope that its value will go up, and eventually when you need the money, you’ll be able to sell it to someone for a price higher than what you acquired it for.
Some asset classes let you earn a stable income and grow your money at the same time. For example, good dividend-paying stocks, that are likely to go up in value.
Basic Features of Investing
The primary goal behind investing is to grow your money!
It usually involves putting your money into assets that can give you more return on investment than the inflation rate. In fact, the aim is to get as high returns as possible.
Now the possibility of higher return comes with its own risks. When you invest your money, there is usually no guaranteed return, and you could also lose your principal amount.
However, to make up for the risk, the return is usually impressive!
SENSEX gave over 14% CAGR (Compounded Annual Growth Rate) since its inception.
Compare it to what 5-7% Fixed Deposit rates or up to 4% interest rate of savings accounts.
The risk associated with investing can be minimised (and avoided!) by sensible asset allocation, and diversification. It is not as hard as people think it is. Even passively investing in the index itself can give you tremendous returns over time.
Differences between Saving and Investing
The primary difference between saving and investing lies in the purpose behind the two. While saving involves keeping aside a portion of your income to cater for short-term needs or goals, and emergencies, investing is done with the sole motive of growing your money with time.
The following lists the key differences between saving and investing:
|Saving involves setting aside a portion of your income to cater for short-term goals or needs and emergency situations.||Investing involves letting your money grow over time, by putting it to work. It is done to cater for long-term financial goals and needs.|
|Saving is usually done by putting your money in some safe and secure place, that allows you to access the money whenever you need it.||Investing is done by putting your money into different asset classes that are likely to increase in value with time.|
|Saving is not done with the aim of growing your money.||The sole aim behind investing is to let your money grow over time.|
|Since money loses its purchasing power over time due to inflation, ideal saving instruments pay an interest rate below or at par with the inflation rate.||Investments are made with the goal of earning as high returns as possible. As a result, investments are expected to give considerably higher returns than inflation.|
|The most important aspect of saving is that you do not want to lose your principal amount. As a result, usually, there is a guaranteed return.||There is a greater chance of losing your money in investing. There is no guaranteed return, and you could also lose your principal amount.|
|The guaranteed return also means low risk, which in turn can be associated with low returns.||No guaranteed return and a greater chance of losing your money mean a higher risk, which in turn gives you an opportunity to earn more.|
|There is a trade-off between the safety and accessibility of your funds and the return on investment. And the safety factor is more important here.||The trade-off in investing is between risk and return. It is popularly called the “risk-return trade-off.” Higher the risk, greater the chances of a high return, and lower the risk, lesser the chances of a high return.|
|Saving gives you financial security and independence.||Investing helps you grow your wealth!|
Now that we know what saving and investing are and how they’re different, let’s have a look at a few popular savings and investment products:
|Savings Instruments||Investment Products|
|Current Accounts||Mutual Funds|
|Certificate of Deposits (CDs)||Bonds|
|Recurring Deposits (RDs)||Gold (or other Commodities)|
|Exchange-Traded Funds (ETFs)|
Time to address the elephant in the room: which is better- saving or investing?
Saving vs. Investing: Is it Better to Save or Invest?
Saving and investing are two complementary elements of an effective personal finance strategy.
One cannot lead a financially sound life without one or the other!
However, the questions we need to ask are how much to save, and how much to invest? and when to invest, and when to save?
When to Invest, and When to Save?
Saving acts as the precursor to investing!
You cannot invest if you’re unable to save anything from your income.
Before you start investing, it is important that you take care of your emergency funds first. Having a safe and easily accessible emergency corpus is the first step toward financial stability.
When to invest, and when to save depends largely on your current financial position, and your short-term and long-term financial needs and goals.
If you’re planning for a vacation next month, or to buy something expensive, you should be saving for it. On the other hand, if you want to retire 20 years down the line and you want a certain retirement corpus, then investing is the best option.
Here’s an ideal priority list. It can vary depending on what you want with your money, and when you want it.
- Saving for an emergency fund.
- Paying-off high-interest short-term debts.
- Saving for short-term needs and goals.
- Investing for long-term needs and goals.
How much to Save, and How much to Invest?
The answer to this question depends on your financial goals, needs and abilities. It varies from person to person based on the quality of life and lifestyle.
However, before you start your investment journey, you need to have a good amount of money in your “rainy-day corpus”.
How much should you have in your emergency fund?
Well, the answer will vary from person to person, but save enough to cover for an emergency like unemployment. Ideally, you should be able to live off your savings for at least three to six months.
But inflation can eventually eat up your savings, and hence putting all your money into savings instruments like savings accounts is a bad idea. This is why you need to look at investing so that you can earn more with your money over a long period of time.
While saving is about taking care of the bare minimum, investing is about growing your wealth, and there’s no limit to how much you should be investing!
Keeping aside a good amount of money as your savings, and then investing patiently and consistently over years can give you the perfect balance.
Let’s end it here! I hope you enjoyed it as much as I enjoyed writing.
Let me know in the comments below if you have any queries or suggestions.