It is quite normal for people to get confused between savings and investments. Lot of individuals tend to believe that putting your money in a bank FD or buying an endowment policy is an investment. People also tend to believe that the money they set aside in a money market mutual fund is an investment. These are just savings as they are meant for an emergency. They cannot create wealth in the long run, which is what investments are all about. At the outset, this confusion between savings and investments is risky because it actually distorts your investment strategy. So, let us look at some of the biggest mistakes that investors make and how to avoid them. These common mistakes in investment management occur when you confuse between investments and savings. Here is how to avoid that confusion.
We use the terms (savings and investment) quite interchangeably. Actually, there is a vast difference between the two. Savings are just money kept aside for a rainy day. So the money you have stacked in your bank savings account or a liquid fund is all examples of savings. Investments are all about wealth creation over the long term. The difference between savings and investment is best captured by the US Securities & Exchange Commission (SEC); “Savings are usually put into the safest places or products that allow you to access your money at any time. Savings have almost zero risk of erosion and therefore the returns on savings are also extremely low.”
Savings are the key to your emergency and liquidity requirements
Savings and investments are not competing with one another but they are two sides of the same coin. As an investor you need both; savings and investments in your portfolio. Here is why..
Savings are meant for emergencies. You could lose your job or plan to start your own business or hit by a medical emergency. You need a liquidity back-up to fall back upon. Hold 5-6 months of your monthly earnings as liquid savings. This comfort will increase your risk appetite.
Investing begins with savings; because if you don’t start saving then what do you invest. Don’t look at savings as the residual but look at expenses as a residual by making savings your target. As income grows, keep raising your savings target and. Out of the money you save, allocate a small portion to liquid assets and the rest to long term wealth creation. Savings are your base.
Savings are essential to ensure that you don’t break into your investments as a matter of principle. Breaking your investments means future wealth compounding opportunities are missed out. Breaking your investment also has negative implications for your tax liability.
But investments are your key to future wealth creation
Bill Gates rightly said that “If you are born poor then it is not your fault but if you die poor then it is entirely your fault.” To put it mildly, investments translate your dreams into reality. Investing is all about getting the power of compounding. When you are invested in equities, for the long term, and you invest with discipline then you are bound to create wealth through the power of investments..
But aren’t equities risky. The beauty of invest is that over the long term the risk in investments are neutralized to a negligible level. Even on a risk-adjusted basis, these long term equity investments tend to be much safer and more prolific. Of course, you must avoid the obvious risks like concentration risk and the cyclical risk. You can achieve these investment goals best with the help of diversified equity funds.
The investment in equity related products has two key advantages. Unlike debt, equity is best positioned to overcome the risk of inflation over a period of time. Also, a diversified product like equity funds is structured to capitalize on alternate economic cycles through strategic stock selection. That is what investing is all about.
Normally financial planning begins with a conservative estimate of equity returns. Over the longer run, they actually tend to perform much better. As a result, funding gaps in your plan automatically get taken care of. That is very important as quite often your outlays cannot keep pace with your rising needs. That is where compounding comes in handy and that is why investments actually matter! When you confuse savings with investments you tend to put your long term money in absolutely sub-optimal instruments. That is the mistake you need to avoid!
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