Translating Savings into Investments for long term

Translating Savings into Investments for long term

At a very basic level, savings represent the excess of income over expenses. Whatever surplus money you stack under your pillow or leave in your bank savings account is your saving. But savings will become investment when they are used for productive investments. We often tend to use the terms savings and investment quite interchangeably. As stated earlier, savings refers to money kept aside for a rainy day. So the money you have stacked in your bank savings account or a liquid fund or any near-cash resource is examples of savings. On the other hand, investments are about wealth creation over the long term. Investing is a disciplined and systematic approach to make your money work harder and compound into a larger corpus over a long period. When you invest, the focus is on the power of compounding by allocating money systematically and intelligently.

 How do savings and investments compare to wealth creation?

The actual fundamental difference between savings and investments become apparent only when you consider the extent of wealth creation over a longer period of time. If you put all your money in a liquid fund, then it is hard to create wealth in the long run. That is because, if you earn 6% on a liquid fund then you earn just about 4% net of tax. That means it will take your corpus 18 years to just double. The same money invested at 12% post-tax returns will grow 8-fold in 18 years. That is what making money work harder is all about. Consider the example table below:

 

Savings Products

Investment Products

Particulars

Bank Savings

Liquid Funds

Balanced Funds

Equity Funds

Monthly Outlay

Rs.10,000

Rs.10,000

Rs.10,000

Rs.10,000

Time Period

20 years

20 years

20 years

20 years

Annual yield

4%

6%

12%

16%

Total Outlay

Rs. 24 lakhs

Rs. 24 lakhs

Rs. 24 lakhs

Rs. 24 lakhs

Value after 20 Yrs

Rs.36.80 lakhs

Rs.46.44 lakhs

Rs.99.91 lakhs

Rs.174.95 lakhs

Corpus/Inv ratio

1.53 times

1.94 times

4.16 times

7.29 times

 

What do you infer from the above table? You can clearly see why investment products create greater wealth over a longer time frame. As you stay invested longer and at higher rates of return; your principal and your return on the principal are reinvested at higher yields. That is simply put; the power of compounding. You may argue that investments entail higher risk. But the biggest risk that most investors are up against is “not taking enough risk”. That way, your allocation becomes sub-optimal. It is all about calibrated risk!

 Some savings must remain in liquid and accessible form

One of the key differences between savings and investments is liquidity. Investments in equity can be less liquid due to price and performance risk. That is why some amount of liquid allocation is essential before you embark on investments. Here is what savings can do for you.

  • Savings are a must for emergencies and they are lurking around the corner all the time. A job loss, decision to set up your own venture, medical emergencies, etc are all cases of emergencies which need money. In these cases, you need liquidity and a liquidity back-up is provided by liquid savings. The thumb rule is to hold 5-6 months of earnings as liquid savings. The comfort of savings allows you to assume the investment risk.
  • Investing begins with savings. While a portion of your savings must be in liquid form, don’t overshoot these liquid targets. The bulk of your savings must still translate into investments. The basic rule is that you must not look at savings as the residual but look at expenses as a residual. As income grows, keep raising your savings target and work your expenses accordingly. Out of the money you save, allocate only a small portion to liquid assets and the rest to long term wealth creation. Savings form the base.
  • A proper savings-investment mix ensures that you do not break your investments unless the situation is absolutely demanding. When you break your investments, you miss out on compounding opportunities. Breaking your investments also has implications for your tax liability and your long term goals.

 Why converting savings into investments is the key?

Investments bridge the gap between dreams and reality. In the above table, the balanced fund at 12% returns is able to multiply your investment 4.16 times but if the returns are higher at 16% then the investment is multiplied 7.29 times. That is the power of compounding. 

  • Remember, over a long time frame the risk inherent in investments tends to get neutralized and that works in favour of your investment returns. Even on a risk-adjusted basis, long term equity investments delivery higher returns.
  • Investments in equity are best positioned to overcome inflation over a period of time. Also, a typical diversified equity fund is structured to capitalize on different economic cycles alternatively over a longer time frame. SIPs can add value to that.
  • Long term equity investing is all about making money work much harder on your behalf. That begins by translating your savings more effectively into long term investments.