Saving and investment are two terms that boggle many of people’s minds. On the surface, these terms refer to the same thing. Is not true that savings is a form of investment? An investment in the future? Well, read on to find out what really is saving and what is investment, and if the terms differ at all.
Understanding saving
Consider Jane, a middle-aged single mother who works as a janitor at an upmarket office in New York. Jane has two sons and one of them, Hendrix, is passionate about performing arts. Hendrix has made it clear that he wants to join The Juilliard School to hone his dancing and drama skills. But guess what, the annual sticker price (tuition, books and supplies, and other fees) for educating a child at The Juilliard School was on the upwards of $65,610 during the 2018/2019 academic year. Can Jane put Hendrix through his school of choice when he comes of age? She thinks she can.
To that end, Jane opened a savings account with Marcus by Goldman Sachs but she can only put there $1,000 per year. The savings account charges an interest rate of 1.70% annually for savings in the account. This means that for the first year, Jane’s savings will earn an interest of (1,000 x 0.017 x 1) = $17. Clearly, even if Jane keeps adding money in the account, she will never save enough in time for Hendrix’ education, who is eight years now.
From the illustration, it is clear that savings represent the money that one keeps away to spend in future. The logic of saving is to be able to afford an item or a service that you cannot access today because it is too expensive. Saving piles up money for a number of years to help you access more expensive things, or to help in an emergency in future.
Read More: Understanding Investing Risk
Understanding investment
Alternatively, Jane can put the $1,000 in the stock market. If she bought 10 shares of Goldman Sachs at $100 each at the beginning of the year and the stock jumps to $300 at the end of the year, Jane would close the year with $3,000 in her account. This is investment. Therefore, investment refers to putting money in an asset whose value grows over time. Such an asset could be a share, a bond or even real estate.
How can you differentiate savings and investment? Here is how. Savings are low risk because many banks that offer the services (like Goldman Sachs) are members of the Federal Deposit Insurance Corporation. This means your money is safe. However, if you invested in the NYSE and the market is hit by a financial crisis, you could lose all your investments.
Another way you can differentiate savings from earnings is to consider the availability of your money. Usually, you can access money in a savings account within a day or week after request. However, retrieving money put away in a stock or real estate requires more effort and time, making it illiquid.
