Money: Understanding the difference between saving and investing
MANAGING YOUR MONEY
By GRAHAM KAJILWA |
3 months ago
Putting a shilling away for a rainy day is a wisdom that many know. However, what many do not know is that the rainy day usually comes faster than we think.
To some, a bank account is the most preferred place for stashing this money while some prefer taking riskier ventures with the money, which boils down to an investment.
While both ways work, Sarah Wanga, head of Research AIB Capital Nairobi, says there is a difference between saving and investing.
“Sometime we confuse the two. However, saving is not necessarily investing,” she says.
So what is the difference?
Saving is when you are just setting money aside for some event or activity. For example you can save for retirement.
Investing is when you seek profit from your money.
So when you are putting your money in an account, you are simply saving, even when the money is in a fixed savings account.
Multiplying your money
“When you put your money in a bank account you are simply saving,” she says.
“Investing is where you are multiplying your money. If you put it in a bank account that would qualify more as saving as interest rates are relatively low.”
There is a confusion between the two ventures given that they both come with risk. For example, a bank or sacco can collapse with your money in it yet you were not using that financial institution as an investment vehicle but savings.
But the institution was risking with your savings by investing.
While in both savings and investing money grows, the latter is associated with high returns.
Wanga says the basic idea behind investing is that you will not be in the same position in the future or at maturity of the investment. While some mode of savings may come with returns, the money may grow at a very slow rate.
Unit trusts, private equity, capital markets, are some of the investment vehicles where one can grow their money. Others are government bonds, Treasury bills and businesses.
“In investment, you consider the return that you are likely to get. The return will be determined by the level of risk you are willing to take,” she explains.
“If you are willing to take a higher risk, your returns are likely to be higher. If the risk is lower, then so is your return.”
Spread your risks
For example, if you put your money in a business, the return is likely to be higher but so is the risk.
“You can even lose more than you invested if you borrowed to fund the business,” she says. It is the same case with investing in private equity.
If you are looking for safety, Treasury bonds and Treasury bills she says, are the go to investment vehicles. They are considered safe but that also comes with their not so high returns.
“It is advisable that when investing, choose a variety of investments as opposed to investing all your money in one venture like say real estate or private equity market. Have a rich portfolio,” says Wanga.
If you are younger, take more risk with your money but for those approaching retirement, Wanga says government bonds and Treasury bills are your best.
And one does not need millions or save for long in order to invest.
For example, she explains, when it comes to stocks one can easily buy 100 which is the minimum in the Nairobi Stock Exchange and it goes for Sh3,000 at Sh30 per share.
Factor in inflation
Reginald Kadzutu, a financial and economic analyst, while acknowledging that people mistake saving and investing, says it does not mean that one is superior to the other.
He however advises that when saving one must factor in inflation. Inflation is the value or percentage of depreciation in the purchasing power of a certain currency.
For example the overall inflation this year as at June 2021 Consumer Price Index released by the Central Bank of Kenya is 6.32 per cent.
Kadzutu gives an example saying if inflation is 6.8 per cent, then your savings reduce by the same value.
If you out in money in January this year and withdraw January next year, that money will buy you things less 6.8 per cent,” he says.
For example if you had Sh1, 000 in your bank account, the value of that money will be Sh932 once inflation is factored.
“That is why you have to make sure your savings are earning at least bare minimum inflation,” he says.
Have a goal
“If you earn slightly higher than that is good because savings are not particularly with a target or goal- its literally just saving as you think of what goal or what to invest in.”
Kenyan Commercial Bank, for example, offers in interest rate of 6.3 per cent on fixed deposit. This is equal to the country’s inflation rate of 6.32 per cent as per the Central Bank of Kenya Consumer Price Index (CPI) report of June 2021.
While to someone the interest rate of 6.3 per cent might be attractive as an investment vehicle, it is more or less saving as you are insuring your money (savings) against inflation notwithstanding that your bank balance at the end of the year will be slightly more than the principal amount you deposited.
Kadzutu says there are some investment vehicles that are good for savings, like money markets.
“There are people who put money in money market accounts and they think they are investing but ideally this is just a savings vehicles as it tries to make sure you earn above inflation that why interest rate are low,” he says.
Kadzutu clarifies that it is not that one is better than the other since for you to get money to invest, you need to save so the question should be; where do you save?
Investments, he says, should be goal oriented unlike savings. This determines the tenure of the investment and the risk one can take.
“Most people go to invest and have no specific goal they are trying to achieve,” he explains.
For example if you want to save for your house, you should ask yourself; when do you want to build the house, which could be in 10 years’ time.
“When you are investing ask yourself: what investment can I put in money where I can get a good return that can help me build a house of Sh10 million?” he says.
If that is your target - to get Sh10 million - then you need to put aside Sh5, 000 every month and it needs to earn 14 per cent interest.
And not all investments are worth diving into, he warns.
For example, it is unwise to put your school fees into a private equity just because of an attractive return of 18 per cent. However if you are not in immediate need of the money, then one can risk. “If you know your goal is in pension, and you saved and invested in such, if your money is in an illiquid investment you won’t be worried because you know as time goes it can be recovered.”
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