One of the biggest arguments that exists is the argument of what came first between the egg and the hen.
In personal finance, one of the most confusing elements is the difference between saving and investing.
Even though the argument of what came first between the egg and the chicken is a tough one, the one between saving and investing isn’t.
Let’s start with basic definitions:
Saving comprises basically of the money left after spending.
Investing on the other hand, is the process of distributing resources with a goal of generating profits or interest.
Do Not Save Money
In the personal finance camp, you will find a fierce group that tries to sound smart and sophisticated by warning people that they shouldn’t save their money. They should invest their money instead.
They say that when you put your money in your bank account, it is losing its purchasing power to inflation.
That is true.
To preserve the value of your money, your savings should be earning an interest rate higher or equal to the inflation rate.
A few years back, you could buy a loaf of bread at Sh 20. Now it goes for Sh 60. That means if you kept Sh 20 in your bank account to use it to buy a loaf of bread today, you cannot afford to buy a loaf of bread since the price of bread has increased as a result of inflation while the value of your money hasn’t increased.
The New Way of Saving Money
The traditional way of saving money entailed putting your money in a piggy bank or a container or under the mattress. This is the same way as saving money in your bank account. The money gains no interest and loses its purchasing power.
Luckily enough, the development of financial markets has seen the introduction of managed funds like money market funds that allow us to preserve cash without losing its value.
What I mean is, instead of saving or accumulating your money in a piggy bank, under your mattress or your bank account where it earns no interest, you can now save your money in a money market fund account where your money fetches a competitive interest rate under a very low management fee.
Ditch Banks’ Saving & Fixed Deposit Accounts
Some of the worst places to save your money are under your mattress, in a savings account or in a fixed deposit account.
This is because these accounts fetch you very little interest rate that can hardly beat the inflation rate.
Never fix your money in a fixed deposit account unless you have a huge amount of money that allows you to negotiate for high interest rates with the bank.
Of course, some banks have realized that their savings and fixed deposit accounts are losing the public interest and are increasing the interest rates on savings.
Save your money in a money market fund instead.
Why Money Market Funds Are Ideal For Saving
1. You can hardly lose your money
You can only lose your money in a money market fund if the fund is mismanaged. This is also unlikely since the funds are overseen by trustees, and other regulators.
2. Decent Interest Rate
Money market funds pool money from investors and invest it in treasury bills and short term bonds and fixed deposit accounts(they can negotiate for high rates since they have a lot of money to fix)
3. Highly Liquid
For most money market funds, you can access your money within a day of asking. Hence you can easily access your money any time you want.
4. Easy to top up
You can top up your savings anytime you want with any amount.
The Difference Between Saving & Investing
Now that we have tackled what saving is and how we should go about it, should one be saving their money or investing it?
This is the same as asking, should a newborn baby try to crawl before walking?
Saving is like crawling while walking is like investing. Without savings, you have no money to invest.
Saving is what fuels investing since you invest what you save.
In short, your investments are a function of your savings.
Why You Should Save Money Before Investing
1. To Create An Emergency Fund
An emergency fund is a pool of money that should cover your expenses for a period of six months. It acts as a backup in case you lose your job. It helps one avoid selling off his assets before maturity date so as to meet their every day bills. Before you invest money in long term assets, it’s advisable to have an emergency fund in place.
2. Entry into High Capital Markets
Even with the introduction of fractional investing in shares, most asset classes still require a decent amount of capital for you to get started. Bonds require a minimum of Sh 50,00. Land and real estate requires even bigger chunks of money. Hence it is important to accumulate this money in a decent place.
Saving is For the Poor, Investing is for the Rich
When you have little money invested, you should focus more on saving more money first or growing your income and focus less on the returns from your investments. This is because, when your portfolio is small, your portfolio will grow more from your savings than from the returns on your investments.
To put this into perspective, let’s assume you can save Sh 1,000 every month for one year. Hence your portfolio now has 12,000 in savings. In your second year, your money that you saved in your first year was invested and earned an interest of 12 per cent per annum. Hence it grew by Sh 1200. But if you continued with your goal of saving Sh 1,000 per month in your second year, by the end of the second year, you’ll have saved another 12,000.
However someone with a big portfolio has a lot of money and should hence shift his focus onto investment returns and not savings.
Nick Maggiulli, the author or Just Keep Buying, summarized this by writing,
“If your Total Assets multiplied by your Expected Annual return is greater than the Expected Savings, this means that your investments are earning you more than you are saving, so you should focus more on your investments. However, if you can feasibly save more money than your assets can earn you in a year, focus on saving.”
The Bottom Line
You can grow wealthy without a high income but you have no chance of building wealth without savings.
Saving is wrong only when done in the wrong way. That is when you save your money in an insecure place where you can easily lose it. Or when you put your savings in a place where it is not earning an interest rate equal to or greater than the inflation rate.