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Friday, September 14, 2012

Are You Saving or Investing?

There are usually two kinds of people – those who have something extra after paying all their monthly expenses and those who don’t.
Let me assume that you belong to the former; otherwise the discussion which follows may be a bit advanced. Now, what do with the left over cash?
  1. Do you stash it in your bank account and spend it whenever you need to buy something big like an iPod, a camera, an LCD TV?
  2.  Do you make a fixed deposit once you get that lump sum payment?
  3.  Do you buy houses, shares, mutual funds or other investments?
3.  is an Investment, 1. is a Saving 2. is, according to me, a Saving  but others will think that it is a form of investment. There are some differences.
The difference between saving and investment is quite clear to comprehend but with citation of relevant examples to support the aspect of each case. It could be simpler than ever imagined even though some people still equate savings to investments. However, given their intrinsic value makes them very distinct financial disciplines.
First, when you invest you create a greater chance of losing what you have invested in case of a calamity unlike when you save, your money remains in banks and federal securities. Money in an investment receives no compensation as a result of a calamity that may lead to loss of your principal. However, saved money must be fully compensated for inclusive of interests if a loss occurs.
In an investment, your money become unavailable to you for use in an emergency unlike in a saving plan where the cash saved is readily accessible. If you are not going to need money in the nearest future, invest in stock markets etc. But if you are going to need the money, don't invest. Instead save it.
Investments generally yield high rate of returns depending on the nature of the activity you have invested in. On the other hand, savings have low rate returns as it relies on bank interest rates or returns on deposit securities.
What you are doing with that extra cash will only be considered as an investment if, and only if, it can significantly grow your money above inflation, after taxation. Remember, when inflation is quoted at around 5%, it’s actually around 6.5% per annum. Therefore, to realize any real returns on your investment, your money will need to grow above that.
I know someone is ready to present evidence that some financial institutions pay around 8% interest on fixed deposit. Reduce that interest by 30% (tax) and you will notice you are only having 5.6%. This still falls below benchmark (6.5% inflation rates).
The focus of every investment is increasing your net worth and achieving financial goals in the long term basis. It offers an opportunity for a greater ROI. However, as the amount of ROI increases and so is the risk of potential loss of the principal invested. This is quite the opposite to your savings i.e. the risks involved with the amount saved are minimal. Majority of savings are insured with the federal deposit security insurance companies.
Value appreciation is quite evident with investments like purchase of market bonds and securities. These investments earn some intrinsic value with time depending on how much you invest. (Note iPods, cars, computers etc, are not investments, they depreciate rather than grow in value.)
Equity/balanced mutual fund units and shares are investments. Their risks are high, but have the potential to grow far beyond inflation. Gold and other commodities are investments too, and so is paintings (art), real estate etc.
Investment can also give returns in terms of cash flows, which are earned on a regular basis. Cash flows are often described as “passive investments” as you do not have to work for it. Dividends (from shares), royalties from books, rent (from real estate) etc are some sources of regular income.
Savings, however, depend on currency value which in reality depreciates with time.
In a nutshell, savings are all that money you have stashed in your bank account, under your pillow and in fixed deposit accounts. The money is often easy to access, are less risky, earn little or no interest and gradually eaten away by inflation.
Savings are your present. Investments are your future. Bestride the two – invest around 40 – 60% of your earning and save the rest. You will always need your savings for your heavy purchases and to help you pay those extraordinary bills (like hospitalization, wedding, pregnancy etc), but do not do without investment either.
For a stable future, invest more. So how do you know that what you are doing is investment no saving? Checks:
  1. It should be able to grow above inflation
  2. It should have some element of risk
  3. It should appreciate in value – through value appreciation or cash flows
  4. It should have limited access
More on investment and savings: Differences Between Saving and Investing:

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