Now that we have understood the concepts behind the processes of savings and investments, it would be pertinent to discuss the major points of difference between the two. As we discussed in my previous article, investment and saving often used as synonyms, and for good reason too. Saving could be understood as a foundation on which the building of investments is constructed. Yet, saving and investment also differ significantly.
The difference between saving and investment could be best understood by comparing them on different criterion in the following manner:
While saving is usually meant for immediate or short term needs, investment is done for needs which have a relatively longer time horizon. While the ultimate objective of investment is to attain significant regular income or capital appreciation for the investor, the maximum that savings could be expected to achieve is value retention by beating the inflation.
Time Frame -
As follows from the first point, the time frame for savings is much smaller than that of investments. The thumb rule is that any objective less than 5 years should be completed from savings, while anything with a longer time frame should come within the purview of investment.
Methods/Instruments Used -
Usually, savings are in the form of cash, or highly liquid instruments such as savings accounts or money market instruments and T-Bills. For investments, instruments such as shares,bonds and mutual funds are preferred.
Ownership Rights –
Some investment options, such as shares, give you an ownership right in the company. For example, if you purchase 1000 shares of SBI or ICICI Bank, you become a part owner of the bank. However, you would not get the ownership rights even if your current account in the bank amounts to Rs 10 lacs.
Form of Profits –
The profits (or returns) from investments can take various forms – interest, dividend or capital gains. The returns from saving instruments would usually be in the form of interest. Of course, cash would give you no returns; on the contrary, it would decline in value (due to inflation).
Quantum of Profits –
As mentioned in the last article on difference between savings and investment, the highest objective that savings could achieve is that they beat the rate of inflation. As such, the rate of returns on savings account is quite modest. The returns from investments (especially over the long term) are significantly higher. Of course, theoretical returns from investment could also be much less, or even negative, which brings us to the next point of distinction, which is…
Level of Risk Involved –
The level of risk associated with the saving instruments is almost negligible, especially since the bank deposits are insured to the extent of Rs 1 lac. Conversely, there is always a level of risk associated with investment instruments, which may vary with the different varieties of instruments. While some investments are highly risky, some are less so. No investment, I repeat, NO investment is actually free from all types of risks.
Thus, it is obvious that saving and investments are two different concepts, though they are quite interrelated and complimentary, like two sides of the same coin. It is important to understand the peculiarities of both the concepts, so that there is no confusion between the two, and the investment plan is adjusted to include both of them. I hope that this article (and the previous one) have cleared your doubts regarding the difference between savings and investment. I would certainly welcome your questions, suggestions and criticisms.