From time to time, I hear people say they want to invest their finances and that the money they are looking to invest is lying in a savings account. What most of them do not realize is that the money in their savings accounts is already invested.
Maybe the best place to begin, then, is to explain how the two concepts marry.
Investing money is the process of using your capital, or money to purchase an asset that you believe has a high chance of generating a profit over time. It also involves putting your money into something, with the hopes of it growing.
Saving, on the other hand, is where you put your money into an account, to preserve and protect it, and to allow it to accrue some considerable compound interest with time.
The two – investing and saving– are short-term and long-term strategies for financial gain.
Should I save or invest first?
This is yet another common question. Analogically, saving money is the basis upon which you build your financial home. So, it will usually come before investing money.
Unless you are from a wealthy family, you will need your savings to serve as capital that feeds into your investments.
Three factors come up when thinking about investment:
This refers to how easy it is for you to withdraw your funds. If you want simple access to your money, then savings accounts are the best option, because they are incredibly liquid. With financial institutions embracing technology, all you need is a Smartphone to transfer your funds.
Stocks are not as liquid as a savings account, although you can sell them easily through a broker. Other investment forms like CDs or real estate are not very liquid since real estate sales need someone to buy before you can get your money out, and cashing out a certificate of deposit (CD) early means incurring losses.
Rate of return
This refers to the amount of money you can reasonably expect after you make an investment. For instance, when investing in a broad stock market, the realistic rate of return you can expect is 7% P.A. For a savings account in Kenya, the rate of return is also 7% P.A. The difference is in the risk you take.
Risk vs. Reward
What are the chances that you will get the return that you hope for with the kind of investment you are making? What is important is for you to analyze the risk and stick to a risk vs. reward ratio that matches your risk appetite.
You can calculate this ratio by dividing the amount you stand to lose if everything shifts to the left by amount of profit you expect to get if the investment closed out
For instance, when you decide to invest in the stock exchange, you should know that they pack significant risk aspects, especially if your goals are short-term. However, if you put your funds in a savings account in Kenya, you are sure of some small positive returns, which quickly add up.
It is clear that a savings account registers on all the factors above; it has high liquidity, presents the least risk of investment, but with minimum expected rate of return.
If you’re wondering where the best place to put your money is, you can use these rules to compare the investment types:
If you need to use the money sooner, then you don’t want to take much risk. For instance, if your savings account in Kenya is dedicated for retirement, then you won’t mind taking a big risk. If you’re saving for a house that you plan to buy in 5 years, you may be all right with a little risk. But if you’re saving for your child’s school fees in 6 months, you don’t want much risk at all.
If you’re going to want to use the money quickly, you need it to be somehow liquid. What that means is you wouldn’t put your emergency money into collectibles or real estate, or put it in a CD. Such investments can be great for the long-term, but not if you need the money quickly. A savings account offers a great choice, since it also allows you to build a rapport with the financial institution you’re working with. This way, you can even access quick loans when you get into problems.
Rate of return shouldn’t guide the decision – in general, you should pay keen attention to the risk and liquidity. Once you figure these two out based on the reason you’re investing, then you can try to shop for the best rate of return for the amount of liquidity and risk you are comfortable with.