![savings vs investments](https://blog.nairacompare.ng/hubfs/Savings%20vs%20Investments%20-%20Which%20is%20Better%20During%20an%20Inflation%201.jpg)
Savings vs Investments: Which is Better During Inflation?
Inflation is when the prices of things we buy go up, and our money buys less than before. It can make us think hard about how to use our money wisely. Should we save it in the bank, or should we invest it in things like stocks or property?
Savings vs investments, which is better during inflation? In this post, we'll explore the difference between the two during inflation and help you understand which might be better for you.
How Inflation Erodes the Value of Savings
To understand the impact of inflation, let's consider a simple example:
Imagine you have ₦100,000 in a savings account that earns no interest. If the annual inflation rate is 5%, here's what happens to your purchasing power over time:
Year | Nominal Value | Real Value (Adjusted for Inflation) |
0 | ₦100,000 | ₦100,000 |
1 | ₦100,000 | ₦95,238 |
2 | ₦100,000 | ₦90,703 |
3 | ₦100,000 | ₦86,384 |
4 | ₦100,000 | ₦82,270 |
5 | ₦100,000 | ₦78,353 |
As you can see, even though the nominal value of your money remains the same, its real value (what you can actually buy with that money) decreases over time due to inflation.
Since prices go up over time, saving alone isn't enough. That's why experts say you should also invest your money to make it grow. Earning returns can help you best inflation. You can preserve and increase your wealth over time.
Savings Accounts
Savings accounts are a basic financial tool that most people are familiar with. They offer a safe place to store money while earning a modest return. Let's explore the pros and cons of savings accounts, especially in the context of inflation.
Pros
- Safety: Savings accounts in trusted banks are usually insured by the Nigeria Deposit Insurance Corporation (NDIC), protecting your money up to a certain amount.
- Liquidity: You can access your funds quickly and easily when needed.
- Ease of Use: Most banks offer online and mobile banking, making it convenient to manage your money.
- Low barrier to entry: You can often open a savings account with a small initial deposit.
Cons
- Low returns: Interest rates on savings accounts are usually low, often below the inflation rate.
- Loses value: As discussed earlier, the real value of your savings can decrease over time due to inflation.
While savings accounts offer security and liquidity, their low returns make them at risk to the effects of inflation. This is why many people consider investments as a way to beat inflation and grow their wealth over time.
Investments
While savings accounts are safe and easy to access, investments provide the potential for higher returns that can help combat inflation. However, they also come with their own set of risks. Let's explore the pros and cons.
Pros
- Higher earning chance: Many investments, such as stocks, real estate, or mutual funds, have helped to beat inflation over the long term.
- Variety: You can spread your risk across various asset classes and sectors.
- Compound growth: Reinvesting your returns can lead to fast growth over time.
- Hedge against inflation: Some investments, like real estate and fixed deposits can serve as natural hedges against inflation.
Cons
- Risk of loss: Unlike savings accounts, investments can decrease in value, leading to losses.
- Uncertainty: Investment values can change in the short term, which can be stressful for some investors.
- Complex: Understanding different investment options can be hard for beginners.
- Less liquidity: Some investments may be difficult to convert to cash quickly without making losses.
Popular Options in Nigeria
Here are some common investment vehicles available to Nigerians:
- Stocks: Ownership shares in publicly traded companies.
- Bonds: Debt securities issued by governments or corporations.
- Mutual Funds: Professionally managed portfolios.
- Real Estate: Properties including residential and commercial properties.
- Treasury Bills: Short-term government securities.
Choosing Between Savings and Investments
Deciding between savings and investments isn't always a straightforward choice. Several factors come into play when making this decision. It may not be a case of choosing one over the other, but rather finding the right balance between the two.
Factors to Consider
1. Time Horizon: How soon will you need the money?- Short-term goals (< 5 years): Savings accounts or low-risk investments
- Long-term goals (> 5 years): Higher-risk investments with growth potential
- Low risk tolerance: Focus on savings and low-risk investments
- High risk tolerance: Consider a more aggressive investment strategy
- Emergency fund: Savings account
- Retirement: Long-term investments
- Down payment for a house: Mix of savings and low-risk investments
- Pay off high-interest debt before investing
- Ensure a stable income before taking on higher-risk investments
Decision Matrix
This quick table can help you make the best decision:
Goal | Time Horizon | Recommended Approach |
Emergency Fund | Short-term | High-yield savings account |
House Down Payment | 2-5 years | Mix of savings and low-risk investments |
Child's Education | 5-15 years | Balanced portfolio of stocks and bonds |
Retirement | 15+ years | Growth-oriented investment portfolio |
Finding the Right Balance
While the debate between savings and investments is often framed as an either/or choice, the reality is that a healthy financial plan includes both. The key is finding the right balance that aligns with your financial goals, risk tolerance, and life stage.
The Importance of Both
- Emergency Fund: A savings account is ideal for your emergency fund, typically 3-6 months of living expenses. This provides a financial safety net without the risk of market changes.
- Short-Term Goals: For goals within the next 1-3 years, savings accounts or low-risk investments are generally more appropriate.
- Long-Term Growth: For long-term goals like retirement, investments offer the potential for higher returns to outpace inflation.
- Variety: Having both savings and investments helps spread your overall financial portfolio, reducing risk.
Strategies for Balancing Savings and Investments
1. The 50/30/20 Rule: This budgeting principle suggests allocating:- 50% of income to needs
- 30% to wants
- 20% to savings and investments
- Immediate needs: High-yield savings account
- 1-2 years: Short-term CDs or bonds
- 2-5 years: Balanced mutual funds
- 5+ years: Stock-heavy portfolio
3. Age-Based Asset Allocation: A common rule of thumb is to subtract your age from 100 to get the percentage of your portfolio that should be in stocks. For example, if you're 30, you might aim for 70% in stocks and 30% in more conservative investments.
Conclusion
As we've explored throughout this post, the choice between savings and investments during periods of inflation isn't always straightforward. Let's recap the key points:
- Inflation's Impact: Inflation erodes the purchasing power of money over time, affecting both savings and investments.
- Savings Accounts: Offer safety and ease of access but offer returns below the inflation rate, leading to a loss of purchasing power over time.
- Investments: Provide the potential for higher returns that can beat inflation but come with increased risk.
- Choosing the Right Strategy: Depends on factors like your time horizon, risk tolerance, and financial goals.
- Balanced Approach: A healthy financial plan often includes both savings and investments, made to fit your situation.
The key takeaway is that there's no one-size-fits-all solution. Your approach should fit your needs, goals, and risk tolerance. Here are some final tips:
- Start with a solid emergency fund in a high-yield savings account.
- For short-term goals (less than 5 years), favour savings or low-risk investments.
- For long-term goals, consider a diverse portfolio that aligns with your risk tolerance.
- Regularly review and adjust your strategy as your needs change.
- Consider seeking advice from a professional for personalized guidance.
Remember, the goal isn't just to save money, but to grow and protect your wealth over time. By understanding the pros and cons of both savings and investments, and how they interact with inflation, you can make informed decisions to secure your future.