Saving Vs Investing

One of my loyal readers asked this question on the previous post.

Saving vs investing. Which is more prudent?

To answer his question, I think it’s best to start at my definition of the two words.

Saving – Putting aside a proportion of your earnings. We covered the basics in that post, and agreed that at minimum, one should save at least 10% of their earnings.

Investing – Placing your savings above in areas where the money has growth potential. This could be in shares, a fixed deposit account, government bills, business etc.

I hope from the definition above, you realise that they’re mutually exclusive. It’s prudent to keep money aside, but you don’t realise the full potential of your savings, unless they’re able to earn you more money.

Two  books I highly recommend for basics of personal finance is Rich Dad Poor Dad, or The Richest Man in Babylon. I say if you’re making money, aren’t in finance and haven’t read any of the two books, you need to. The two explain finances in such basic terms, that I find myself re reading them time and again, just to remind self. If stories are your thing, the second title would be interesting to read.

The question should instead be, of our savings how much should we hold in cash?

Where should the money be invested?

This post will cover the first question, and the next question will be covered in my next post.

In my opinion, the only money that should be held in cash (or semi cash form such as a fixed deposit, or limited withdrawals savings account) is your emergency fund.

Experts recommend that we put aside at least 3 months worth of our monthly expenses as an emergency fund, to insulate against loss of income. This is to protect you in  case you lose your job (it is assumed that in 3 months, one would have an alternate income generating activity), salary delays, etc.

This is the point where I step down from my pedestal. In my over 3 years of employment, I haven’t set up an emergency fund that’s this big yet. I’m starting out on one now, after a salary delay demonstrated how real this can be. I’m in the habit of investing all my savings, which isn’t wise too.

Where should your emergency fund be held?

This depends on the amounts, which we calculate as: 3 X your monthly expenses (which you get from the budget).

Having this money lying in your operations account isn’t the wisest thing to do, hence one should have multiple accounts. I recommend an operations account and a savings account with limited withdrawals per month, or quarter, one that doesn’t have an ATM card. If the two are in the same bank, you can even set up a free standing order, such that when the salary hits your account, the bank saves for you by transferring your savings before you touch the money.

1 month’s worth of expenses can be held in this account, the rest held in a form that earns you slightly more than the bank rate, but you can easily realise the money if need be. For this, I would recommended government securities, such as T Bills (which we’ll talk about in this series about investing). Having your emergency fund in shares isn’t a good idea because as much as it’s easy to sell your shares and get the money when you need it, your need might arise in such a time when the market is low, and you’re forced to sell at a loss.

Mo, this should sort out your problem, where no matter what you earn, you spend it all.

I don’t advocate for forced savings, but critical items call for critical measures.