Ninety-five percent of Americans work for someone else. Most of these workers put away money to save every single month, whether into a savings account or money market accounts, these two being the most common forms of saving money.
But we must deduce why exactly people are putting money into these accounts?
It is because they believe that these accounts have little to no risk. Money accumulates based off compound interest. The account will only go up, never go down. That’s where the “no risk” comes in.
However, what most people don’t know is that their savings accounts are still subject to inflation risk. And this is something that most people are uneducated in. They are unaware of how their $1000 that they put away this year may not have the same purchasing power the following year. Although they are accumulating interest, the money and interest being accumulated is not following the economy fast enough.
Now don’t get me wrong, I am not against savings accounts. I want to advocate the fact that there’s a time to put money into your savings account and a time not to. It boils down to how well you can manage your money during different times in the economy.
Let’s look at a prime example:
In 2007, the highest interest rate on savings accounts ranged around 5% APY.
This means that if you put away $10,000 at the beginning of the year, then by the end of the year you would have $10,512.67 if your interest was compounded daily.
Savings Account: $10,000 / 5% APY = $10,512.67
The average annual inflation rate for 2007 is 3.8%.
Putting in the same $10,000, by the end of 2007, your money would have the purchasing power of 10,383.96.
Inflation: $10,000 in 2007 -> 3.8% inflation rate -> $10,383.96 in 2008.
Meaning what cost you $10,000 in 2007 now costs you $10,383.96 in 2008.
Because you had your money in your savings account however, you’ve accumulated $10,512.67. Your savings account has surpassed the inflation rate and made you a positive net return of $128.71.
Now let’s use the same analysis on 2009: the market’s rock bottom era.
Savings account: $10,000 / 1.4% APY = $10,140.98
Inflation: $10,000 in 2009 -> 1.4% -> $10,163.98 in 2010
Meaning what cost you $10,000 in 2009 now costs you $10,163.98
Meaning that if you had saved up $10,000 to purchase something in 2009, you now need to save up an additional $163.98 in order to buy it. But because your savings account is working for you at 1.4% APY, your savings account now has $10,140.98 which STILL sets you at a deficit of $23 dollars.
The point of this article is to show that the old way of saving money is no longer relevant to today’s economy. The traditional saying of “save your money” from what our parents and what our grandparents said no longer holds true.
This is because back in their time, saving money actually meant “saving money”. Back in their time, the dollar bill was still held to the gold standard so saving money was literally saving gold. Since the dollar bill broke away from the gold standard in 1971 and inflation kicked in, people must devise new ways of saving money.
Saving money in the 21st century includes a combination hybrid system of investing and savings. When savings accounts can not keep up with inflation, it’s a good idea to take your money out of savings accounts and put it into other investments instead.
It really boils down to how the economy is doing and how much return you’re getting off your accounts. Be sure to keep a sharp conscious about this, other wise you would be hemorrhaging money and not even know it. The old traditional ways are gone, so adapt to the new systems or else it’ll leave you dry.
(Sources:
Interest calculator: http://www.bankofinternet.com/interest-calculator.aspx
Inflation rates: http://www.usinflationcalculator.com/
Financial Freedom Blog: Financial Freedom)
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