Saving and Investing

Saving and Investing Similarities & Differences

What are some similarities and differences between saving and investing? Well, both are, of course, money management skills. However, investing differs from saving because it is a little more involved. There are various investment options and strategies. There are only so many ways to save, but there are infinitely many ways to invest. In addition, you don't have to have money to invest to start with. You can borrow, invest, earn a return and then repay what you borrowed as long as you are sure that the return you get is greater than the interest on your loan.

Saving and Investing Strategies

What are some of the saving and investing strategies? Let's go over them in turn!

Saving Strategies

You can save your money in cash under your mattress, but it's a pretty inefficient way of saving. Why? One reason is simple; where do you store all that cash? Also, do you really want to risk all of your savings being stolen from your house? Finally, there is inflation - which means that your money's buying power will be declining daily in a rising price environment.

Another strategy is to open a savings account in a bank which gives an option of compound interest. Compound interest essentially gives you interest on interest at regular time intervals, such as monthly, quarterly, or yearly. The interest amount is added to the principal amount, making your future interest income even higher. Even though some banks may not necessarily offer interest that would keep up with the inflation rate, you can still earn quite a bit of return on your savings over a significant time horizon.

Saving, pixabay

The longer the time over which the interest is compounded, the more return you will get. Also, the more frequently the interest is compounded, the more return you will get.

Imagine you save $10,000 instead of $100 with compounding and leave the money to earn interest over 10-20 years! The returns become much more substantial than what you saw in the example above.

Investing Strategies

After putting some money aside, investing is basically the next step to earn you more interest than a regular savings account would. There are many ways to invest. Let's consider some of the most popular ones:

• Stocks
• Bonds
• Treasury instruments
• Real estate

Investing, pixabay

When you invest in a stock market, you essentially buy a piece of the company you invest in. How so? Well, if the company is listed on the stock exchange, then it raises funds from the general public. This means that your money will be used to fund the company's day-to-day operations and, if it becomes successful, can earn you a decent return. You can buy a stock at a low value and wait for the price to rise and sell it. Alternatively, you can hold onto it and receive regular payments called dividends.

Governments and corporations often raise funding for their projects by issuing bonds. The general public buys these bonds and holds onto a piece of paper that promises that the issuing entity will return this money at a future date with interest. This future date is called the maturity date. Generally, bonds are considered a less risky investment than stocks simply because the entities that issue them have a better reputation in the financial market. In addition, companies that issue them do everything they can to fulfill their promise to repay, knowing that if they don't make their bond payments, their cost of borrowing will go up, and their reputation will suffer, making it harder to raise funds in the future.

Treasury instruments in the U.S. include Treasury Bills, Treasury Bonds, and Treasury Notes. All of these are ways you can lend some money to the government and earn some interest at various maturities. These are considered the least risky investments as you can buy them directly from the government, and there is a very low probability of a government default.

Finally, you can invest in buying a property you can live in and pass down to your children, thereby lessening their future financial burden. It is generally a good idea to take out a mortgage and repay it in installments at regular intervals. The catch? You often need a large down payment and a good credit score. In addition, you are paying the interest on your mortgage. The return will be positive only in the case that the future value of your property rises above what you bought it for, plus the interest you paid on top.

The Role of Savings and Investment in Economic Development

Savings and investment affect economic growth, which indirectly feeds into economic development. The ideas work the same as for an individual, but on an aggregate level.Economic development implies improving people's living standards. But how are the living standards measured? Various indirect factors correlate with a higher level of economic development, such as high real GDP per capita, low unemployment, low and stable inflation, a sustainable level of the national debt, and a balanced balance of payments. These can be achieved through economic growth.

Saving and Investment Relationship

Saving and investment are linked at an aggregate level in the loanable funds market. Banks loan out the money you put in your savings account to other individuals and businesses. All individuals' savings comprise the total amount of loanable funds that the banks can advance as loans. The more money is saved on an aggregate level, the more the supply of loanable funds will be. Greater availability of credit results in lower interest rates. This stimulates more firms and individuals to invest, as they can now borrow money for their investment at a lower interest rate. Ultimately, the more savings there are, the more investment there is in the economy.

Figure 1. Saving in the loanable funds market, StudySmarter Originals

Figure 1 above shows what happens when more individuals in the economy decide to save. The supply of loanable funds increases from S to S', leading to a drop in the interest rate from r to r'. At this lower interest rate, the quantity of loanable funds demanded is higher (Q' compared to Q).