Understand the difference between Savings and Investment
We all know that there is a difference between Savings and Investment. However, not many of us think through our personal finance strategy in terms of Savings and Investment. End of this article, I want each one of us to objectively analyze our portfolio. Also, classify each item as Savings or Investment as a first step.
Savings is money you put aside. It may be an emergency fund or towards a specific short-term goal like taking a vacation or buying a car or electronic gadget. The money stashed away by our moms in kitchen jars and by small kids in piggy banks is also Savings. Savings are typically risk-free and therefore yield very low or nominal returns.
Savings is typically idle money and therefore it is prudent to keep only that is absolutely necessary to take care of your emergency needs. I am a little conservative and therefore always keep one month of my salary in my Savings Bank Account that can be retrieved anytime at the click of a button. In current times, you earn 3.5% interest per annum on this balance. Post-tax this is almost negligible. But the purpose of this is not to earn money but to have money readily on hand in case of an emergency. However, you now have Small Finance Banks and some Private Sector Banks that offer up to 4-6% per annum on savings accounts balance.
So, determine your monthly float basis your responsibilities and needs. Park them in a Savings Account and monitor it 3 to 6 months to understand your spending pattern and accordingly increase or lower the balance. To meet your short-term goals, open a Recurring Deposit Account and park funds on a regular basis till your goal is achieved. This brings about a certain financial discipline apart from earning a nominal rate of interest.
Investment in other words means to create wealth. In order to meet our long-term goals like buying a house, saving for kid’s education or marriage or retirement fund it is important that we invest our savings in various assets classes to generate income. Investments are tricky and involve risk. Higher the risk, higher the return. However, it is important we understand the risks associated, expected returns, holding period and invest accordingly.
For instance, typically investment in real estate should be limited to one house property unless you have excess cash. Reasons being rental income from a house property is typically around 2-4% per annum in India. Also, the holding period is very long to unlock value in real estate, many at times it is almost a generation! Investing in stocks requires a lot of knowledge and time. Therefore, many tend to lean towards mutual funds were the risk is relatively lower as a qualified Fund Manager manages the funds. We will separately dissect the various asset classes that exist and returns that one can expect out of them.
But having understood the difference between savings and investment, please revisit your portfolio and bucket them between the two. Monitor your savings and move excess to investment category.
Please check out my post on ‘Personal Finance Tracker’ which contains a simple excel spreadsheet which will help you collate all your data in one place and aid in easy monitoring.
Do this simple exercise and watch this space for some basic investment ideas to get you started!