Think Beyond Savings and Think Investments

Difference between savings and investments

Investors often get confused between savings and investments. That is hardly surprising. They believe that parking surplus funds in a bank FD or in a safe liquid fund are an investment. The answer is that it is not. When you have a surplus of income over spending, that is the first step. You can either keep the money under the pillow or park it in a bank. Both are savings because there is no risk element and no wealth creation element. You do need some liquidity for emergencies but saving for liquidity is not investing.

Then what is investing? This was best answered by the US SEC, which defined savings as “Money put into the safest places or products that allow you to access your money at any time. Savings have almost zero risk of erosion and therefore the returns on savings are also extremely low.”  That is as clear as it can get. SEC also defines investment as “Taking a greater chance of losing money than when you save. The money you invest in equity and mutual funds is not insured by the government. But that is a risk you take to earn higher returns and compound wealth over a period of time”. Now you know what is investing.

Investments create better wealth than savings

Let us look at two scenarios; where we put money in a savings product versus putting money in an investment product. Check this table.

# (All yields are in post-tax terms)

The above table underlines how equity-linked investment products create wealth. It is the power of equities and the power of compounding combined. Above all, the favourable tax treatment of equities also enables better wealth creation in investment products. In investing, you take higher risks in search of higher returns with a long-term perspective.

Don’t forget that; savings are the gateway to investments

Now don’t start looking at savings and investments as competing products. They actually complement. You first generate surpluses by spending less than your earnings. Then you set aside a sum for emergencies, which is your savings to fall back upon. The rest is invested.

1. Why are savings like emergency funds? You live with uncertainties like bad market cycles, business losses, loss of job, medical exigencies etc. Set aside 5-6 months of income as liquid savings to improve risk appetite.
2. To invest, you first need to save, but where and how do you start? If you wait till you earn enough to start saving, you will never be able to save. You must set a goal and work backwards to check your required savings. Remember, investing must only start after your emergency fund. However, savings need to be squeezed out of income, so it will only work if you set a saving target and then work your expenses.

It is investments that bridge present and future

Investments are the bridge that leads you from dreams to fruition. It converts your surplus funds into productive assets that can work hard for you in the long run. The beauty of investing is that in the long term, the risk tends to get neutralized and that works in favour of the risk-return trade-off. So just start with a plan and translate your dreams into actionable goals. Then savings and investment start to make a lot of sense.