There are two kinds of people, really - those who have extra money left over at the end of the month, and those who don't.
I'm assuming you're one of the former; otherwise you shouldn't even be here. So what do you do with what's left over?
- Do you put it in a bank account, and spend it whenever you have a big purchase like an LCD TV, an iPod, a camera?
- Do you make a fixed deposit every month (or once you have a large sum)
- Do you buy mutual funds, shares, or other investments?
1. is a Saving. 3. is an Investment. 2 is "Saving" according to me (but others will. think of it as an investment) There's a difference!
An Investment is where you can grow your money significantly above inflation, after tax is applied. Remember that quoted inflation is around 5% but for real terms, it's around 6.5% a year. That means your money needs to grow ABOVE That for any real returns. An investment MUST carry some amount of risk; assured returns are usually negative post-tax and post-inflation.
Savings are everything else. Money in the bank, in a fixed deposit, hidden in your pillow etc. Even bonds and debt mutual funds, in my opinion, are "savings" - they hardly return more than inflation post tax.
You might think "No! A fixed deposit can grow at 8% a year!" Reduce tax on that amount at 30%, you'll get 5.6% left over. That's still less than inflation of 6.5%.
Shares and equity/balanced mutual fund units are investments. They carry a large amount of risk, but have the potential to grow much more than inflation. Gold and other commodities are investments too, and so is real estate, paintings (art) etc.
Within investments you have two types: cash-flow and value-appreciation. Cash-flow means you get money ever so often; royalties from books, dividends, rent (from real estate) etc. Cash-flow income is usually called "passive income"; meaning you don't have to work for it.
Value appreciation is growth in the intrinsic value of what you buy. (Note: Cars, iPods etc. are not investments. They lose value from the minute you buy them!)
Most people usually buy for value appreciation, since there are limited cash-flow options available. In India for instance, both dividends and rents are around 3% post-tax, and that's no fun. But there are a few companies that consistently give 10% dividends, and places where you can get upto 7% as rents. You just have to look harder.
Investments are your future. Savings are your present. Straddle the two - keep around 40-60% of your money in investments and the rest in savings. You need your savings to build up your purchases and pay extraordinary bills (like a pregnancy or hospitalisation), but don't forego your investments either.
If you want to ensure a stable future, invest more. Key check:
- It should "appreciate" in value (either through cash flow of value appreciation).
- It should have an element of risk.
- It should have the ability to grow more than inflation.
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