This article was published in India Today Money on 1 April 2016
The difference between “Saving” and “Investing”
These two words are used casually and interchangeably by a majority of people we meet during counseling.
Here is a quiz to test your understanding – Fill in the blank with “saving” or “investing”.
1. I have _______ in an Life Insurance policy.
2. I have _______ in PPF.
3. I am buying an office space for my ________.
4. I am ________ in a Mutual Fund for long term for my child.
Which words did you fill in the blanks and why? Pause and think.
Read on for further clarity.
Let us explore the difference between the two and why it is important to deeply understand the underlying concept.
Let us say that all of us start at Zero net assets i.e. Zero wealth, at the beginning of our career. Of course there could be a few of us fortunate enough to inherit wealth. But for the purpose of this discussion, let us assume that we are Zero wealth when we start out. The journey to get wealthy is typically as follows:
First, we have a “money surplus” situation on monthly basis i.e. Earning more than spend.
Then we start to have some accumulate surplus monthly or yearly till we feel secure that we have some buffer should we have an urgent need of money.
Third as our situation improves further, we start to desire things we need to buy – maybe a bike, clothes, car or a house.
Fourth, we start to desire(want) certain items – maybe a fancy music system, a nice vacation etc.
Fifth, if after most of our needs and wants are fulfilled, we start looking at options to put the money left over, into areas with the intention of generating more money for us in future.
Saving is something one does from stage 1 till 4. Today, the world has banks and finance companies to give us loans to get our objects of needs or desires. But leave loans aside for this discussion.
Investing occurs only from 5th stage onwards. This is a very important and simple concept.
In planning for our present and future needs, we need to understand that to get wealth, we need to traverse the journey in steps and stages and can not jump to the next stage without building a good foundation of earlier stages.
Core Principle being – First Save then Invest.
Saving -is a process where one puts away small amounts of money to add up to a certain large amount. Example, I remember our mothers used to put away a small amount saved every month in an envelope to buy that saree or a new mixer for the kitchen. That is perfect example of saving. Note here that the housewife gives no thought to the rate of interest or rate of return etc. Rate of return do not matter much for the person saving as long the saving goal is met within the time period specified. In the olden days before banks, people saved in pots (buried in the garden!) and piggy banks and envelopes or with friends (called kitty, bhishi etc). People even saved up a whole amount for constructing their house or constructed their house in instalments as and when they saved up some amount. Literally, people use to build their homes one room at a time!
This fine habit makes India a “saving” country. Overall, our Household savings rate is impressive amongst other countries in the world at 26%. But, this savings rate has been coming down with the rise in urban, upwardly mobile middle class over last ten years.
People have forgotten the simple habit of saving before buying the object of one’s desires. As a child one had to save pocket money to buy comics, toys, board games, cricket bat. Now parents just buy it for their kids as affluence rises among urban families. In my opinion, kids must be encouraged to save for things so that they value it more, get more joy from things.
With the advent of credit cards, the habit of savings has taken a hit. People believe that their credit card is the god that creates money out of thin air! No, it does not. You have to pay the bills later!
Investing- is a process whereby one puts away “surplus” money to generate more money(returns) for us in the future. Key word here is surplus. Meaning after you have put away enough money for the things you really really need(Must-do).
In investing, one key factor is rate of return. Obviously, this becomes an important factor as this is sole reason of deploying money in this manner.
On the journey to wealth, young people get into a trap starting to invest before they have saved enough for their must have goals. If you know you need definite amount of money, say for child’s education, in ten years time, you should save for it. Yes, rate of return matters but more important is that you certainly reach your goal amount.
Similarly, if one is not saving enough for retirement, when we know we are going to stop earning from say age 60 onwards, no point putting money in second or third property investment. This is a foolish practice but a lot of people do it.
First save for essential, then invest (from whatever is left).
This may look like I am promoting a slow way to get wealth. But believe me, slow and steady wins the money race just like the hare and the tortoise story. This lesson learnt will help you make quick progress on whatever you ar seeking from your life.
And ultimately, isn’t that the point of making money?