There is a big difference between saving, investing and speculating with money.
Savings is putting money away safely for future use in a low interest account.
Investing is putting capital into an asset of value for either potential cash flow or appreciation.
Speculating is betting on an asset increasing dramatically in value mostly due to the behavior of other buyers.
Introduction to Savings
Savings is the amount of your current income that is not spent on goods and services that you put in an account and don’t spend. Savings accounts are usually with banks and provide a safe place to store money for specific future needs like emergencies.
Currently savings accounts pay almost nothing in interest with the low rates set from central banks. Savings accounts are not used for earning interest, their purpose is to hedge personal finances from risk and create safety for when extra money is needed.
Saving is simply holding back money from consumption to give a margin of safety to personal finances. Short-term savings is a hedge against financial risk. Long-term savings can depreciate with inflation as it’s kept in currency. Savings can be converted to an investing account to seek returns ones savings goals are met.
They primary use of a savings account is to be used as an emergency fund instead of credit cards. The purpose of a savings account is to have access to fast cash when needed.
What is investing and how does it work?
Buying a stock that pays a dividend is an investment.
Buying a stock that has a low price that doesn’t accurately reflect the future discounted cash flows of the underlying company or asset value is considered value investing.
Buying a real estate property to rent out to tenants that creates cash flow that is greater than the mortgage debt payment is considered an investment.
People will also invest in precious metals like gold and silver to try to hold the buying power of their money. Businesses, oil wells, and anything that creates cash flow can be considered an investment.
An investor buys perceived intrinsic value that can be quantified.
“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” – Benjamin Graham
Speculating is buying something in an expectation of future price appreciation based on the belief that price will go higher based on others buying it or it becoming valuable or creating cash flow in the future. In a speculation the current value is not quantified yet. A speculation can be considered more of a bet than an investment.
“If somebody had told me my method would not work I nevertheless would have tried it out to make sure for myself, for when I am wrong only one thing convinces me of it, and that is, to lose money. And I am only right when I make money. That is speculating.” – Jesse Lauriston Livermore
Knowing the difference between these three types of financial decisions is a very important first step in any financial journey. In personal finance you must understand the purpose of savings, the value of investing, and the opportunities along with the dangers of speculation.
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