I am often asked about the difference between saving and investing. Some people think the two terms are interchangeable. They are right – but only up to a point. Both saving and investing are delayed consumption. When we put our money in a savings account or into the stock market, we forgo consuming something today, so that we might have more money to spend later on. In other words, we are deliberately delaying our spending. We might, for instance, consciously forgo buying a new pair of shoes today. We probably don’t need them anyway. So by skipping an impulse purchase…
I am often asked about the difference between saving and investing. Some people think the two terms are interchangeable.
They are right – but only up to a point.
Both saving and investing are delayed consumption. When we put our money in a savings account or into the stock market, we forgo consuming something today, so that we might have more money to spend later on.
In other words, we are deliberately delaying our spending.
We might, for instance, consciously forgo buying a new pair of shoes today. We probably don’t need them anyway. So by skipping an impulse purchase today, we could have more options as to how we could spend our money later on.
Same but different
But saving and investing differ in terms of the length of time that we leave the money untouched. Saving is generally meant for accumulating money to buy things in the not-too-distant future.
So, we might sacrifice buying our cups of morning coffee in order that we have more money to spend on a holiday at the end of the year.
Investing is different. It is delaying spending money today so that we can have more to spend many years from now.
So we save for the short term but we invest for the long term.
We should never try to invest for our short-term goals. We should not even think about investing, if we need the money within the next five to seven years.
But we should be investing for our retirement because that could be many decades away.
In the short term, it is not necessary to think too long and hard about the kind returns we might get on our money.
The interest that we earn over the short term is unlikely to make that much of a difference, especially when the rates paid on savings accounts today are abysmally low. It is more important to know that the money will be there when we need it.
A losing game
But it is precisely because interest rates are low that we should not keep our money in a savings or deposit account for too long.
If you think that playing the savings game will help you achieve your long-term financial goals, then you are participating in a game that you can’t win.
The odds are heavily stacked against you. With interest rates on some popular savings accounts paying just 0.05%, you don’t stand a cat’s chance of beating inflation.
Core inflation in Singapore is running at 1%. So money in a savings account is growing at a considerably slower rate than prices are rising. To put it bluntly, our money in the bank is shrinking.
Not much better
Bonds are not that much better and the property market is vulnerable to the whims of central bankers. But stocks, especially dividend-paying stocks look a better option.
For starters, the Straits Times Index is currently yielding 3.2%, which is more than eight times the Singapore average benchmark interest rate. It is also 64 times the interest we could earn in a typical savings account.
You could get a higher yield by targetting specific companies, especially those that have a good track record of raising their dividends.
Let’s say you buy a share for $1and it pays a dividend of 5 cents. That is a yield of 5%. Now suppose that next year the dividend is raised to 6 cents and 7 cents the year after.
It means that you could be earning a yield of 7% on your original money without even factoring in any growth in the share price. Chances are the shares might rise as the dividends are lifted.
And if you reinvest those dividends you get even more shares that generate more dividends, which hastens the compounding effect. That is the beauty of long-term investing.
That to me makes a lot more sense than watching the purchasing power of our money shrink, which is exactly what could happen if you leave it in a savings account for too long.
A version of this article first appeared in Take Stock Singapore. Click here now for your FREE subscription to Take Stock – Singapore, The Motley Fool’s free investing newsletter.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.