Transitioning from Saving to Investing
Date Published: February 24, 2023
Sujoy Mukherjee is a 34 year old father of two. He holds a good job and his wife also earn an income from a part-time job as a teacher. Sujoy is conscious of having to provide for the future of his family and has been disciplined to live by a budget. He lives in a house he bought a few years back and pays an EMI on it. Sujoy and his wife are able to save a good portion of their income each month. Their money is held in bank deposits that they create every once in a while. Sujoy is comfortable with short-term deposits since it gives him the comfort of being able to access the money whenever he needs it. He sees their home, the contributions to provident fund and insurance plans and savings as doing enough to secure his family’s future. Are the Mukherjees missing out on anything in this plan?
The Mukherjees are doing a number of things right such as being able to live by a budget and save a good portion of their income. The mistake they are making is in not making a distinction between saving and investment. Money saved is money that is being accumulated and held in a way that it is easily accessible and without any risk. It is typically held in bank accounts and deposits. Holding money in this fashion is suitable for their needs that are immediate or unexpected. But not all their future requirements will be of this nature. Having all their money in these avenues is a costly choice they are making because the trade-off for the safety and liquidity it provides is the lower returns.
The money Sujoy is saving is an asset that has the potential to generate higher returns which will help him reach his goals faster. The amount of money that has to be set aside from their current income will come down, since the returns that will be generated will add to the corpus being created for their future needs. They can use the income so freed to meet other goals, or improve the present quality of life of the family. To enhance the earning capacity of their money, Sujoy must make conscious choices to invest the money instead of leaving it in the bank account by default.
Investments provide higher returns but come with the risk of lower liquidity and fluctuating values. Sujoy can manage these risks by aligning the appropriate investment horizon for the investment products he is considering with the time horizon of his goals. Funds required immediately and for emergencies should be held in bank accounts and deposits. Funds allocated for their longer term goals should be held in investments that will give better returns and whose risks are reduced in the longer holding period available. Sujoy must also periodically review and modify the investment choices he has made to ensure that they continue to be suitable for the current investment horizon of his goals and his preferences.