It’s important to know the difference between investing and saving. Each serves different functions, and one isn’t always better than the other.
Investing and saving can seem like two different worlds sometimes. However, it’s important for Singaporeans – even if they aren’t in the finance industry – to know the difference between the two.
The key thing to note is that they serve different functions.
What’s the Difference Between Investing and Saving?
Savings are monies that you set aside for emergencies. These need to be liquid – that is, you must be able to get the cash from savings on short notice. An example would be some extra cash stored in a current account, which you could grab whenever you want.
Savings ensure that you have money to cope with immediate financial difficulties, such as medical costs or getting retrenched. When you have savings, you don’t need to borrow money or use personal loans to deal with these situations.
Investments serve a totally different purpose. Investments help you to hedge against inflation (i.e. grow your money to match the rising cost of living), and to increase your wealth to last throughout retirement.
This means investments are not meant to be fiddled with, except for tasks like portfolio rebalancing. If you get into an emergency, one of the worst things that can happen is having to cash out your investments.
If you have a lot of units in a unit trust fund, for example, you don’t know how much they will be worth if you cash them out during an emergency. If you happen to be in a market downturn, you may lose money by having to sell the units at a lower price than you paid for them.
Is Investing Better Than Saving?
No, but this is a common misconception. The reason some people believe investing is better than saving is that savings don’t grow your money. In fact, savings can cost you money.
For example, a typical savings fund is capped at six months of your income. This is considered financially prudent for most people. So if you make S$4,000 a month, you should aim to save S$24,000.
However, this S$24,000, because it’s not invested, will not grow. Inflation will eat into it every year. We can calculate the real value of S$24,000 with the following formula:
Future value = amount /(1+inflation rate)^number years
Assume an inflation rate of three per cent, which is common in developed countries like Singapore, and a period of 15 years. By the end of that time, your S$24,000 in savings would only have real purchasing power of around S$15,404.
Does This Mean You Can’t Rely on Savings Alone to Retire?
Well, yes and no. You can rely on savings alone to retire, but you’d need a lot of money to be able to do that. You need to stash aside enough money that, even with inflation, rising medical costs, diminishing income as you age, etc. can be overcome.
For example, let’s say you want at least S$500,000 in real purchasing power, by the time you retire in 30 years (that’s not a lot at all; remember this retirement sum may have to last you around 25 years or more, assuming retirement at 65).
You don’t want to invest, and you intend to do this by just literally hoarding money until you reach this amount.
Now reversing the above formula*, we find that real purchasing power of S$250,000 in 30 years means you’d need to accumulate about S$1,213,630 in today’s dollars.
You’d be setting aside almost S$3,371 per month, every month for the next 30 years. Remember you’d have to set aside this amount on top of paying all your bills, such as your home loan, and using the same money to deal with emergencies.
It’s not impossible if your income is to the tune of S$15,000 a month or more. But it’s hardly an easy or comfortable way to live, even if you have an income that high.
*amount x (1 + inflation rate)^number years
Investing is Better Than Saving for Retirement Planning
As you can see, using savings alone to build a retirement fund is possible, but not probable for most people. The average Singaporean will need something like an endowment plan, CPF Special Account, or unit trust funds in order grow wealth.
However, if savings are not the best tool for retirement, remember that investing is not the best tool for emergencies. Investments are seldom easy to convert to cash, as they tend to be committed for the long term.
For example, if you invest heavily in a house, you are hoping it will appreciate in value. You may want to sell it at retirement and live off the returns. But if a loved one gets sick next today and urgently needs cash, how will you get it out of your house?
Property is not something you can sell on the spot, and you’re not guaranteed to get a good price selling in such a hurry.
Use the Right Tool For the Right Job
It’s important to both save and invest.
If you feel it’s a struggle to do both at once, then focus on saving alone until you have a fund of at least three months of your income. After that, split the money you set aside between your savings and your investments.
Once your savings have built up to six months of your income, you can safely shift the money you set aside to more investment related products.
Speak to a financial adviser for more help on this, as everyone’s situation is a little different. You may be able to invest a little more or less, based on your own needs.
Read This Next:
By Ryan Ong
Ryan has been writing about finance for the last 10 years. He also has his fingers in a lot of other pies, having written for publications such as Men’s Health, Her World, Esquire, and Yahoo! Finance.