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How Your Savings Today Act as Investments for Tomorrow
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No matter where you are on your journey toward financial freedom, there are two fundamental principles of personal finance that you need to get familiar with. These are savings and investments.
Often, most people confuse the two terms with one another or may be under the misconception that savings are the same as investments. The truth, however, is that they are not. Let’s take a closer look at savings and investments and how you can convert your savings today into your investments tomorrow.
What are savings?
The term ‘savings’ refers to the money you left in hand after subtracting all your expenses from your income. To put it more simply, it is the money left over at the end of the month.
For example, say your monthly financial statement looks like the details shown below.
Particulars
Amount
Total salary earned during the month
₹75,000
Total interest from fixed deposits
₹25,000
Gross monthly income
₹1,00,000
Essential expenses (rent, grocery, fuel, etc.)
₹50,000
Other discretionary spends
₹20,000
Total monthly expenses
₹70,000
In the example shown above, the monthly savings will be ₹30,000 (i.e., ₹1,00,000 minus ₹70,000).
Typically, the money that you save can be deposited in a savings bank account to preserve the funds. You will earn some nominal interest on the savings you make, but other than that, the primary goal of a savings bank account is to keep your money intact.
What are investments?
Investments, unlike savings, are aligned with the financial goal of capital appreciation rather than mere capital preservation. In other words, investing helps your money grow, while savings prevent you from losing your money. Investing involves putting your money in assets, plans, and schemes that are designed to offer a significant return on the principal invested.
The money that you save periodically can then be invested in various schemes and assets, such as the following:
How can you save up today to invest better tomorrow?
To put your savings to good use, you need to know how you can best convert them into fruitful investments.
The conventional method to use your savings for investing involves letting a lump sum amount build up in your savings account and then withdrawing your savings to invest the entire sum in an investment of your choice. This kind of strategy works well for investment avenues like fixed deposits, annual PPF contributions of ₹1.5 lakh, and even the down payment on your home loan.
You can also convert your savings into investments in small sums using a SIP. Here, you periodically invest a fixed sum of money (even as low as ₹1,000) in mutual funds of your choice. Clearly, you don’t need to wait to accumulate a lump sum to start investing via this method.
The power of compounding holds the secret to how your savings today can act as investments for tomorrow. Compounding essentially means you earn returns on your returns. For instance, say you invest ₹1,00,000 at an interest rate of 8% per annum.
Without compounding, you will only earn ₹8,000 each year. So, at the end of 5 years, for instance, you will have ₹1,40,000 only. However, with compounding, here is a preview of how your money will grow over the same 5-year period.
Particulars
Amount at the beginning of the year
Interest earned during the year
Closing balance at the end of the year
Year 1
₹1,00,000
₹8,000
₹1,08,000
Year 2
₹1,08,000
₹8,640
₹1,16,640
Year 3
₹1,16,640
₹9,331
₹1,25,971
Year 4
₹1,25,971
₹10,078
₹1,36,049
Year 5
₹1,36,049
₹10,884
₹1,46,933
As you can see, with compounding, you earn interest on your interest, thus allowing your money to grow exponentially. To use today’s savings for investments that give you the benefit of compounding, you can choose investment options such as the following:
- Mutual funds
- Cumulative fixed deposits
- National Savings Scheme (NSC)
- Unit Linked Insurance Plans (ULIPs)
Conclusion
With the strategies outlined above, you can make the most of your savings and convert them into investments that make your financial goals easier to achieve. When you are planning to invest your savings, however, remember to align your investment portfolio with your financial goals rather than investing randomly. This will be extremely beneficial for your finances in the long run.
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