Money Management
November 11, 2024
.jpg)
Putting money aside for future use is the cornerstone of financial planning. It is the only way to protect yourself from unforeseen emergencies and guarantee financial security. But what approach should you take when accumulating money?
Should you be saving or investing?
Saving and investing are two strategies that can help you accumulate wealth. But they are entirely different concepts. While they both involve accumulating money, their level of risk makes them black and white.
To build wealth, you need a combination of both. You need to know when to choose to save and when to invest. This will ensure you achieve both your short-term goals, like going on a vacation, and your long-term goals of travelling all around the world when you retire.
To understand when to choose what, you need to know how both strategies work and their benefit.
This article will explore everything you need to know about saving and investing, their pros and cons, and what you need to consider when choosing a strategy that will work for you.
Read Also: 10 Rules of Making Money You Should Know
Savings is the portion of your income that is not spent after deducting all your expenses. That remaining money is usually kept in safe accounts and securities you can access easily.
People save for multiple reasons, but the main ones are usually to cushion themselves against financial emergencies and afford large purchases without taking a loan. For this reason, saving is usually based on understanding the time value of money, i.e., the concept that a shilling today is more valuable than a shilling a year from now. In the long run, every shilling you save matters.
When it comes to saving, the most significant problem people usually need help with is deciding how much they should save. There is no one shoe that fits all, as people have different needs.
But ideally, the more you can save, the better.
To reach your savings goal, you need to do three things:
Everyone knows they need to prioritise saving, but as you know, saving isn't simple. You need discipline and self-motivation to do it.
For beginners, you will need to adopt the 50/30/20 budget rule that helps you save 20% of your monthly income.
Answering the question of why you need to save money will require an exhaustive list. But when watered down, it comes to six significant reasons:
Read Also: 10 Effective Money-Saving Challenges to Try in 2023
There are many saving vehicles to choose from. But your choice will be dictated by multiple factors, including:
Your Savings Goal: How you save for retirement and how you save for emergencies will be different. The former will require that you keep your money in less accessible accounts like a pension fund, while the latter will require you to keep your money in easily accessible accounts like a savings account.
Your Returns: Different savings accounts will generate different returns. You need to choose a saving plan that will produce enough returns to keep up with inflation.
Your Risk Tolerance: Saving instruments have different risk exposures. If you are a risk-averse person, you should choose saving vehicles that offer deposit insurance, like fixed deposits from CBK-regulated banks or government bonds. If you are a risk taker, you can save money on equity funds and corporate bonds.
With that out of the way, some saving instruments you should consider are saving plans offered by commercial banks, money market and mutual funds accounts, Saccos, treasury bonds and bills, pension funds, annuities, life insurance, gold, real estate, etc.
Read Also: Why You Struggle To Save – Money Psychology
Now that you know what saving money entails, should you start saving?
This pro and con list will help you make more informed decisions based on your individual needs.
Read Also: 6 Saving Tips For Low-Income Earners
The Oxford dictionary defines investing as the act of putting (money) into financial schemes, shares, property, or a commercial venture with the expectation of achieving a profit.
Investing, unlike saving, usually requires some risk-taking. When you invest money, you take on risk in anticipation of higher returns.
Risk refers to the possibility of losing some or all of the money you have invested. Investing is based on the risk-reward conundrum—the more risk an investment carries, the higher the potential rewards. Investment exposed to low risk generates low-to-moderate returns.
There are two types of investing:
Active investing: This method involves taking a hands-on approach. You will need to research, build and maintain your portfolio. It requires more time, financial knowledge, desire, and taking more risks. Active investing promises more potential rewards.
Examples of active investing: starting a business, investing and trading individual securities, real estate, etc.
Passive investing: This method involves putting your investment on autopilot. It requires putting your money in an investment vehicle where someone else will invest for you. In return, they will charge you some fees or share profits. Passive investing is relatively safer, simple, and offers predictable returns.
Examples of passive investments include mutual funds, index funds, Real Estate Investment Trusts, retirement funds, and savings.
Read Also: Understanding Active and Passive Investment
You must have heard of people talking about "making your money work for you." They essentially mean investing, which involves using your money to make more.
But why should you do it?
To understand, here's what you stand to gain by investing your money:
Read Also: How To Turn Your Savings Into Investments
Investing money can be an intimidating exercise, especially for beginners. With many investment opportunities out there, how do you decide where to invest your money?
You need to consider five things:
Your Investment Goals: What do you want to achieve in the short and long term by investing? Why are you investing? Do you want higher returns or to preserve your capital? Answering those questions will help you pick the investment vehicle that suits your needs.
Your Investment Experience: If you don't have enough investing experience or knowledge, you should consider starting with simple instruments and progress from there. This ensures you avoid investment mistakes that can lead to losses.
Your Risk Tolerance: How much volatility can you withstand? It is important that you only invest money you can afford to lose. Your risk tolerance will guide your investment strategy. Therefore, allocate your assets in a manner that balances your risk and potential rewards.
Your Savings: Do you have a fallback plan if your money goes up in smoke? Before you start investing, you should consider building an emergency fund.
Type of Investment: Do you want to generate income or grow your money through investing? Some investments offer guaranteed payments in the form of dividends or interest, while others appreciate in value, helping you build wealth passively. You need to pick the ones that align with your ultimate goals.
Read Also: Investment 101: Most Popular Investment Types in Kenya
Investing offers a way to grow wealth, but its inherent risk of potentially losing initial investment scares many people away.
To understand whether investing is a good option for you, you need to know all the advantages and disadvantages associated with it.
Read Also: Investing for Beginners: How to Get Started
When should you save, and when should you invest?
Your decision will be informed by different factors, including:
Your Timeline: When will you need the money? Saving is a better option if you need the money in one year or less. But if you need to use the money in five years, you should consider investing it to allow for maximum gains as you have time to ride out market volatility.
Let's say you plan to buy a house in 10 years. With such an extended timeline, you should consider investing, but as your timeline approaches an end towards the 8th or 9th year, you can transition to saving.
What you Need the Money For: How do you intend to spend the money? Your goals will inform this. If you plan to buy a consumer product like a new fridge or you want to replenish your rainy day fund, you should save money. But when thinking about long-term goals like paying for your newborn college fees or your retirement lifestyle, you should consider investing to ensure maximum returns and protect your money's purchasing power.
Your Financial Knowledge: Saving is more beginner friendly than investing. Therefore, you should ensure you have a basic understanding of risk-taking and asset allocation before you start investing. However, you can leverage the use of a financial advisor to help you with research and risk evaluation.
Read Also: 'I Save Ksh35K Monthly, But I Don't Know How to Invest'
Overall Financial Well-being: Before investing, you must ensure you are financially healthy. Therefore, if you have high-interest debt, no emergency funds, and no insurance, you should consider saving to give yourself a financial fallback before you start investing.
Your Needs: Are you looking to make a profit or preserve your cash? If you want more returns, you will have to take the risk of investing more aggressively.
The Costs: Investing is usually associated with more costs and tax implications than savings. Whatever instrument you pick, you should ensure that the investment has good after-cost returns.
How Much Time you Have: Unlike savings, it is hard to automate your investing, and it will require a lot of time to manage and rebalance your portfolio. If you are busy and can't hire an expert to manage your investment, you should consider saving. Putting your investments on autopilot can affect returns and expose you to more risks.
Read Also: Investments to Guarantee You Will Never Run Out of Income
To keep yourself financially stable now and chase your dream of reaching financial independence, you will need to save and invest simultaneously. To achieve both goals, you should protect yourself by building a cash cushion of one year's worth of expenses. Once you have that locked, you can start investing.
Investing has the potential to generate higher returns. However, you should approach it diligently. Ensure that you do enough research, pay attention to your risk profile, and consider your financial requirements.
.png){kind=small}
Join 1.5M Kenyans using Money254 to find better loans, savings accounts, and money tips today.
Money 254 is a new platform focused on helping you make more out of the money you have. We've created a simple, fast and secure way to find and compare financial products that best match your needs. All of the information shown is from products available at established financial institutions that our team of experts has tirelessly collected.
