I had lunch with an old friend of mine last week whom I was meeting after a couple of years. My friend, a young hardworking guy, had recently made a smart career move and was now thinking of settling down and during my discussion with him, we were reviewing some investment decisions he had made a few years back and he was telling me about how he felt that his ‘savings’ weren’t satisfactory enough. However I noticed throughout my discussion that my friend was using the words ‘investments’ and ‘savings’ interchangeably. However I discovered that a lot of people confuse between the two and there are some similarities between the two, however they are two very different entities with different objectives and characteristics.
Savings is defined in the dictionary as ‘The accumulation of money for future use’ while an Investment is defined as ‘the laying out of money or capital in an enterprise with the expectation of profit’. Dictionary definitions aside, an investment is where you can grow your money at a significant rate after taxes. The current inflation in India is at about 8-9% which is pretty high. There are a lot of people who say that this is an aberration and in the long term inflation would settle down at about 5%. I do not know what the future holds or when the inflation would settle down at a more reasonable rate but what I do know is that if you keep your money in your savings bank account, you are losing the purchase value of your hard earned money which is akin to losing money. If you have put in your money in some financial instrument which earns you a ‘real’ return which exceeds the inflation rate, I would say that it has the characteristics of an investment.
A ‘saving’ is basically the accumulation of a certain amount of money in your ordinary savings account or even debt funds or in your piggy bank to fund some big ticket purchase like a swanky vacation, a car, a higher education degree, an iPod or that new plasma TV! (Cars, LCD TVs etc are not investments since they start depreciating in value the moment you step out of the showroom!).Your savings rarely return more than inflation after accounting for taxes.
Investments usually employ two methods through which they grow the invested money
1) By giving a regular cash flow like rent from real estate, royalty from books or art etc.
2) Value appreciation of the assets purchased (eg. Value appreciation of stocks, real estate, gold and other commodities)
Most investments are based on value appreciation, since the opportunities for cash flow are limited. Investments which give a high return in the long term (like shares or equity mutual funds) usually carry a certain amount of risk. However it has been historically proved that no investment can beat the returns that equity can give in the long term.
Investments are for your future while savings are for your present needs. It would be prudent to keep at least 40% of your surplus cash in investments which by their very nature are for a long term holding. Keep some amount as savings also to meet your planned purchases and any unexpected expenses (like hospitalization or an unforeseen expense). The more you are able to invest, the more corpus would you have in your future. The more you have in your long term fund, the more stable our future is financially.