Savings and Investing are two words that are often used interchangeably, but these two words do have very stark differences. One important thing to know is that both of these are extremely important components to achieving financial independence. The main idea behind both of these activities is to exercise restraint and learn delayed gratification i.e. sacrificing something now for something better in the future.
The rule of thumb to consider with saving and investing is that saving is for the short term and investing is for the long-term i.e. we should not save a to achieve a long-term goal and should not using investing to achieve short term goals. Savings are better suited to achieve short term goals like going on a vacation or buying that new phone or emergency funds. Investing is better suited for long-term goals like buying a house, paying for a college education, planning retirement. Keeping this in mind lets see some of the key differences between saving and investing:
Savings: When you make savings in Fixed Deposits (FD), Recurring Deposits (RD) or Provident Funds (PF) your funds have little risk of loss, but, as we all know, with little risk comes little reward. Almost all savings accounts are designed to take on minimum risks and provide you with steady returns. These returns are low and do not work out efficiently in the long run as inflation can have a negative effect on them. The low returns of most savings make them not suitable for long term goals.
Investment: When you make investments in instruments like Equity Mutual Funds, Hybrid Funds, and other types of Mutual Funds they are designed to provide investors with the highest returns while mitigating market risks, but the main objective is almost always to provide investors with the highest returns. The effort to maximize returns causes these funds to carry greater risks, mostly associated with market volatility. The high risks associated with these funds makes them ideal for long term investments as the volatility in the market usually pays off handsomely in the long run.
Savings: A general rule of thumb is that, as the risk goes down the liquidity increases and as vice versa. Therefore, Savings Accounts carry high liquidity and you are usually able to access your funds instantly.
Investment: Investments like Equity Mutual Funds carry a higher grade of risk as the fund manager has usually made investments that are designed to pay off in the long term and, therefore, discourage investors from withdrawing their investment. Withdrawals in the short-term are controlled by charging penalties for withdrawal in the form of Exit Loads.
Effect of Inflation
Inflation is expressed in percentage and denotes the diminishing purchasing power of the currency i.e. the steady increase in the price of certain basic goods and services with a proportionate increase in the purchasing power of a Rupee.
Savings: Savings Accounts provide you with returns between 4% and 6%, these returns annually beat inflation but over the long run may not be able to mitigate the effect of inflation.
Investments: Investments are designed to provide high returns, these returns can be between 15% to 20%, these high returns provide good protection against the effects of inflation on your funds.
What is the difference between long-term and short-term?
If investments are for long-term and savings are better for the short-term, what is the difference between short-term and long-term? Generally, anything less than 5 years is considered short-term, but when it comes to saving or investing these timelines do not matter that much, what matters more is the goal. The goal for which either savings or investments are being made will have different requirements. Investments and savings are usually chosen for the risk grade they carry. For smaller goals with a definite amount to be accumulated in a specific amount of time, like, buying a car or planning a vacation, savings might be a better option. There are other goals which are much broader in nature, like, planning for marriage, planning for retirement, etc. which do not have a very definite amount to accumulate, investments might be a better option as they are designed to provide you with very good returns and usually in the long term.