Most of us use the words ‘saving’ and ‘investment’ as synonyms. Yet there is a substantial difference between the two. On the other hand, there are indeed a number of similarities too. I hope I have not managed to confuse you by this time! But trust me, the two words are quite different in meanings and implications, though they also share a number of common features. Indeed, you could understand them as part of a single financial process, and are definitely complimentary in nature. Let me explain!
Savings Vs Investments
Before I start listing the rather ‘technical’ points of difference between savings and investments, let me try to define the two words.
Saving is the simple process of putting aside a part of your earnings, usually in the form of cash in hand or a savings account, or in the form of some highly liquid (and safe) instruments such as government issued treasury bills
Investment is spending money (or capital) to purchase an instrument or asset that would generate secure and reasonable returns, income or capital appreciation over a period of time.
As is apparent from the above definitions, saving is a rather passive activity, it needs nothing more than putting aside a certain amount of money from what you are regularly earning as an income. On the other hand, investment is much more active in nature. It involves spending money (usually from your savings) to purchase a particular asset that would perform according to your long term financial objective. Thus, whereas saving is usually short-term in nature (usually five years and lesser), investment has a much larger time horizon, lasting up to several decades.
On a closer look, you could also say that saving and investment are really parts of the same process, in which investments starts where saving ends. Or in other words, the process of saving is preliminary to the process of investment. After all, where are you going to gt the money to invest if you have not saved it beforehand? you can consider saving as a base, a foundation on which you would erect your investment edifice! The height, grandeur and longevity of that edifice would depend on , you guessed it right, the strength of the foundation.
But it is also important to understand that investment is not the sole or exclusive purpose of saving – in fact, it has some very important objectives of its own. For example, if your monthly income is Rs 10000, and you want to purchase a sofa set worth Rs 20000, you could start saving Rs 4000 for the next five months, and complete the purchase. You do not really need to make investments to make that purchase! Similarly, you also need to save some money to pay your insurance premium that falls due after every three months. Therefore, you can say that expenses with a short time horizon need savings, not investments.
Investment is a vehicle that is used for long-term financial objectives, say for retiring in a comfortable manner. Of course, sometimes these two processes intermix so closely that it becomes difficult to distinguish between them – for example, you may save money to make down payment to buy a flat, but that buying of flat is an investment in itself.
It is absolutely important to understand that investment and savings are actually two different things, and need a different approach. Understanding the difference and similarities between the two would certainly go a long way in helping you to plan you finances properly. In my next article, we would discuss the major points of difference between savings and investment.