Right from the first paycheck you receive in your hands, you have this question, Do I save or invest. This is a question several people ask themselves on a daily basis. But, unfortunately, a huge amount of people also believe these both are the same things. But trust us, these are different.
The decision to save or invest is a complex one. It varies from person to person. So let us see if it’s better to save your money or invest it.
Before we understand what is better, we need to understand their meanings first. Saving is setting aside some money that you earn. You may set aside this money in the form of cash or keep it with your bank either in a savings account or fixed deposits.
Investing your money is when you buy assets that can help you create wealth generally over the long term. Investing in stocks, mutual funds, ETFs, real estate, etc. These investments may also generate current income for the investors in the form of dividends, rents, etc.
Now that we have seen what savings and investing means, let us look at their advantages and disadvantages.
Advantages and disadvantages of Savings
The following are the benefits of savings:
- Help on rainy days: Savings are usually kept aside for times of emergencies. The savings amount in cash, savings accounts are accessible easily. You can even break most fixed deposits without much issue. The general rule of thumb is to have at least 6 months of expenses as savings at any time.
- Lower risk: Your savings generally have lower risks than investments. You will not lose the amount in your savings account or locker, even if the stock or property market tumbles by 50%. The value of cash, savings accounts do not change unless you withdraw or deposit.
- Savings enables you to invest: If you do not manage to save money, you will be unable to invest. Savings can be seen as the starting point for investing. It is usually suggested to have a decent savings amount to meet any financial emergencies and then start investing.
The following are the disadvantages of savings:
- Inflation leads to negative returns: In the long term, the returns earned on your fixed deposits or savings account fail to beat the inflation levels. This leads to real negative returns where you lose money. Cash in itself does not earn anything. If kept idle, owing to inflation, the cash also loses value. In the finance world, it’s often said, a $1 today is more valuable than a $1 tomorrow.
- Missing out on opportunities: if you keep holding your savings in cash or accounts and do not invest them, you are losing out on possible inflation-beating returns. There should be some amount in hand for emergencies, but the rest can be deployed to generate wealth over the long term.
Advantages and disadvantages of Investing
The following are the advantages of investing:
- Higher return potential: By investing in assets like stocks, ETFs, mutual funds, you can earn returns that comfortably beat inflation. The CAGR of Nifty 50 is 12%. This implies that you can double your investment in just six years.
- Different sources of income: If you save, you can earn only the interest on the deposits. If you invest, you can get dividends if invested in equities, rental income in properties, and capital appreciation. Capital appreciation happens when the value of your investment rises over time.
The following are the main disadvantages of investing:
- Investments may lose value: The value of your investments depends on economic and market factors. In case of negative economic conditions or negative sentiments in markets, your investments may lose value. The value may even fall below what you had invested, meaning that you incur losses on your capital. There is essentially no safety net.
- Higher risk: The investment world is filled with uncertainties. It is therefore recommended that only people who can afford to take some risk venture into investing. Despite the gains in the long-term, the short-term falls may scare away several investors with losses.
- Requires selling to have real funds: The stocks, mutual funds, properties are all assets. To buy something, you will have to transform these into cash, which would require selling them.
When should you save?
Many people look down upon savings since it does not create wealth. But it should not be neglected. You should look to save first if you do not have enough money to cover at least six months of your expenses. So even if you lose your job, you can have fewer money worries for six months. You should also look to save if the goal you are looking to achieve is in the short term. For example, saving for higher education. Investing for the short term is pretty risky.
When should you invest?
In investing, there are chances of you losing the capital. Therefore, you should look to invest only when you can afford to take risks. You can also invest if your goal is to be achieved in the long term. For example, you can start investing today to build a retirement corpus.
The investing vs saving debacle will keep going on for decades. In the end, the decision comes down to the goals and risk-taking capacity of the individual. Those who have a decent income can save and invest at the same time.