Saving and investing are two important concepts in personal financial planning. These two are related but are entirely different from one another. Before one begins the journey towards wealth building and financial independence, one must be able to differentiate between the two.
Before investing, one must first develop the habit of saving. To save is to put aside an amount of cash in a financial instrument that is relatively safe (low risk), easily accessible (liquid), and can earn a small income. The purpose or goal of these funds are primarily to preserve capital (capital preservation), and secondarily, to earn interest to keep pace with inflation. Because of its low income-potential, savings are usually for short-term needs, typically two years or less. Examples of financial instruments for savings are bank savings account, time deposits, bonds and treasury bills.
Investing on the other hand is to purchase something with the intent of gaining something from it (profit) in the future. It is actually using money (capital) to purchase an asset that would eventually provide an acceptable return over a period of time. The goal of investing is to grow your capital (capital appreciation), making one wealthier over time. There are different types of investments. These could be real estate, a small business, stocks, mutual funds, bonds, precious gems and jewelry, art pieces, etc. Investments can provide higher returns compared to savings and could build your wealth through it but it would take time because of risks involved. Investments therefore, are usually for long-term financial goals and are less liquid or not as easily convertible to cash compared to your savings.
Saving vs Investing: How Much is Needed
One needs to save first before investing. The idea behind this is that your savings will be the one to feed your investment. Unless, you win the lotto and become a millionaire. How would we know if we have enough savings and can start investing? The rule of thumb is to have savings amount equivalent to 6 months your expenses. Anything more than that should be invested.
Let’s say for example, your monthly expense is P30,000.00 You should have a savings equivalent to P180,000. Anything more than that must be put in an instrument earning more than your bank account.
Question: Should you save for your retirement? Or invest for it?
I’ll give my answer on my future post.