A nickel ain’t worth a dime anymore.Yogi Berra
You hear it all the time, everyone’s always telling you to save your money, save your money, save your money.
It’s true, saving your money is extremely important. You should always be keeping more money in your savings account than in your checking account.
However, where you keep your money is as equally important as how much of it you’re actually saving. Did you know, that your savings account is losing value every year?
A savings account loses value due to inflation
Before we learn why your savings account is losing value every year, we first need to understand something about inflation.
What is inflation?
Inflation refers to the general increase in prices of goods and services and decrease in the purchasing value of money.
Let’s say you have $1. Today, you can use that $1 to buy a coffee at the local coffee shop.
However, everyone else in town is also buying their coffee from the same coffee shop. As more people buy the coffee (demand increases), the less coffee they have to offer.
The coffee shop cannot significantly increase production immediately (supply remains the same), so the price of their coffee rises. A coffee now costs $1.15.
Your dollar used to buy a coffee, but now that same dollar can no longer buy the coffee.
The purchasing value of your dollar has decreased, because the price of a coffee has increased. Inflation.
So what does inflation have to do with my savings account?
If you didn’t know, the inflation rate in the United States has averaged 3.27% from 1914 until 2019 (source: Trading Economics). This means that on average, the price of goods and services increases more than 3% every year.
Now, this doesn’t mean every year it increases 3%. That’s just what the average has been within the past 100+ years. In fact, at the time of this writing (early 2021), the average inflation rate for the past 12 years has been less than 2% (source: Statista).
However, it is important to understand that most years we see the purchasing value of our money fall due to inflation. This is bad for your savings account because if you put $500 away in your savings a year ago, you will not be able to buy as much with that same $500 today.
“But that’s why my savings account earns interest…”
When you put your money in a savings account, your bank or credit union is taking that money and lending it to other borrowers, charging them interest. The bank/credit union then rewards you with a little bit of that interest as a “thanks for letting me make more money off of your money.”
The typical interest rate for a savings account is a whopping 0.09%. When they lend your money to others (in the form of loans), they can charge anywhere from 2% to 20% in interest. In return, they only give you back 0.09% interest.
What’s worse, is that we saw before that inflation is between 2-3%, but your money is only growing at less than 0.1% in a savings account! Your savings account is losing value!
Inflation vs Savings Account Case Study
Let’s do a simple little case study. Let’s say that in back in 2010 you put away $1000 in your savings account and your bank gave you a very generous 0.25% interest rate.
A quick online calculator will show your that after 5 years, your account will have just $1,012.58. If we go to a simple inflation calculator instead, we would see that $1,000 in 2010 is equivalent to just $908.46 in 2015, or 5 years later.
So, you put $1,000 away in a savings account. After 5 years it grew to almost $1,013, but is only actually worth about $910.
Investing your money is better than letting it stagnate in a savings account.
I’m not saying to take all our money out of your savings account. You should always have some money in your savings for an emergency fund since a savings account is such a low-risk option for your money. However, anything over your emergency fund should be diversified elsewhere.
(Ideally, your emergency fund should be about 6 months worth of living expenses)
The key to reducing the effects of inflation is to invest your money.
I won’t go into too much detail here, that’s for another post, but there are many different ways to invest your money, some more riskier than the others.
Knowing that inflation is rising at about 2-3% every year, you’ll want to find a place to put your money that will either beat or exceed that amount.
Here is a small list of some common forms of investing that can help you beat the rate of inflation:
- Certificates of Deposit
- Money Market Accounts
- Index Funds
- Real Estate
Do you have a favorite investing method? Comment below!
Keeping 100% your money in your savings account isn’t the best strategy. Inflation causes the value of your dollar to decrease about 3% annually. The interest on your savings account is only about 0.025%.
Money in your savings account is stagnating and losing value due to inflation.
You should keep an emergency fund of 6 months of your living expenses in your savings account. Anything more than that you should find a better way of investing your money.