Have you heard the story of the old merchant who gave his two sons a gold coin each before he set out on a pilgrimage? “Sons,” he said, “I am giving you this money — you are free to use it as you wish. But when I return, you must show me what you have done.” The merchant then went away for a few years. Upon his return, he approached his two sons to find out what they had done with the money.
“Father,” said his older son proudly, “Here is the gold coin you gave me all those years ago. I kept it safe in a padlocked box under my bed. The key was on my person at all times so that none may touch it.”
Then the younger son came forward and smiling put down a bag of gold coins at his father’s feet. “Father, I used the gold coin you gave me to start a business. Here are the profits I have made over the years.”
That there, my friends, is the exact difference between saving and investing. When you save money, you basically park it somewhere safe, where you can access it easily anytime you want. However, this money is not only not growing in value, it actually loses value if you let it sit too long (the purchasing power that Rs.1000 in your savings account can give you today will be much less in ten years).
What the second son did was to invest his money. He chose to start a business with it and reaped a handsome profit. While this sounds like the smart thing to do, remember that the business could have failed and he could have lost his original investment too (risk). And if his father had returned just a few weeks after he had invested his money, he would have had nothing to show him (lack of liquidity).
So, should I save or invest?
The answer to that is simple — do both.
All of us need easy access to liquid funds in case of an emergency — job loss, illness or accident — but we also need to invest our money to accumulate wealth over the years. You have to save to be able to invest. The big question then is not really which one but how much.
Unfortunately there is no rule of thumb I can give you that says save X% and invest Y%. That’s because the right answer depends on you — your life stage, liabilities, future plans, and so on. However, we can give you some tips to get started.
Do you have existing debt?
If you have large outstanding loans or unpaid credit card bills on which you are currently paying interest, any disposable cash you have should go towards clearing these. It makes no sense to pay more than what you owe when you have the money to close these out.
Do you have a rainy day fund?
This is your emergency fund that you can dip into in case of unforeseen setbacks. Ideally, this should be about 6 months worth your living expense but don’t go and multiply your current salary by 6 to calculate this sum. Remember that in case of an emergency, you would also be cutting back on your lifestyle choices — lesser shopping, lesser eating and drinking out, moving in with your parents/siblings, and so on.
That means the actual amount you’d need to cover your essential expenditures would be far less. Calculate this amount, multiply it by 6 and that’s the sum you need to put aside. Under no circumstances (apart from a real emergency, of course) should you touch this.
Are you up for some risk?
Now, we know this is a stupid question — hardly anyone ever says yes to this. That’s because most of us perceive the word ‘risk’ negatively. But if you really think about it, aren’t you taking a risk every time you step out of the house? When you cross the road, when you sign up for that adventure tour, when you unquestioningly swallow a medicine your doc prescribed, when you propose to someone you’ve secretly liked for a long time?
To my mind, all of these seem far greater risks (potentially hazardous to heart and health!) than investing a sum of money in mutual funds. In fact, the biggest risk is not taking this risk — parking your money in your savings account will only make it lose its value.
Secondly, you won’t be blindly picking the first fund you come across and parking your entire life savings in it. There is a LOT of information and advice out there on managing your finances and we know it’s easy to feel overwhelmed. We’d say pick one source that is reliable, informative and easy to understand and stick to that. If you’re new to investing, we recommend you start with our posts on investing basics. They will tell you everything you need to know to get started.
The second thing to remember is that not all mutual funds are high on risk — this holds true mainly for equity funds, where the potential for higher returns is also much higher. Debt funds are relatively low risk and liquid funds are as safe as fixed deposits.
Start with our mutual fund explorer tool to find out which ones beat saving accounts hands down at surprisingly acceptable levels of risk.