Why You Can’t Afford to use Savings Accounts for Saving

Maybe you think you’re being financially responsible.  You’ve spent your whole life living within your means: Avoiding debt, eschewing credit cards, driving older cars, and socking away any extra money into your savings account.

 

Maybe you’re just getting your life back on track.  You’ve been bogged down by bad debts for years, and are finally on the verge of paying them off.  As you look to switch gears from paying down debt to building your savings you’ve begun to budget for how much money you should be socking away into your savings account each month.  Because that’s what responsible people do.

Or do they?

While putting money into a savings account is definitely a better than living in debt and spending all of your excess money, its not the best thing you could do.  You see, much like how it costs money to be in debt (in the form of interest) it also costs money to stash away your savings (in the form of inflation).  Yes, it actually costs you money to save your money.  And the more money you have, the more it costs.

What is Inflation?

Inflation is defined as “a general increase in prices and fall in the purchasing value of money.” Simply put, its when the price of goods goes up and things become more expensive (much like how gasoline prices have increased recently).  Inflation can be driven by a number of things.  Increased demand, short supply, even government policy -like low interest rates and something called ‘quantitative easing’ (that’s a separate subject by itself).

Inflation works be decreasing the value of money. In October 2021, the year over year inflation rate was 6.2%.  This means that if you were to put $20,000 into your savings account in October 2020, 12 months later you would functionally be left with only $18,760.  You never spent the money, but its gone.  Forever.  While technically your balance would still display as $20,000 (or really $20,012 assuming your bank pays the industry average interest rate of .06%) what used to cost $18,760 no costs $20,000.  So if a car used to cost $18,760 in 2020 you could have purchased it in 2020 and had $1240 left over.  If you were to purchase the same car in 2021 though, you’d now only be left with $12.  Unfortunately even high interest bank accounts (which have interest rates up to .6%) don’t come close to combating the ravaging effects of inflation.

Thats not to say you’re better off spending your money.  Far from it.

The truth is, Financially Responsible people don’t save their money, stashing it away for some future day.  They invest their money, using it to build wealth for their future.  Sure, everybody needs a savings account for a rainy day fund, or a fund for emergencies, but this fund should be no more than 3 months of your necessary expenses (I say necessary, because if you truly are in an emergency, you wouldn’t need to budget for going out to eat and other discretionary spending).  Once your emergency stash is saved up, the rest should go straight to investing.

Investing your money

While stashing your money away costs you, investing your money actually earns you money.  While you would have lost 6% of your money using a savings account in the past year, you would have actually earned over 40% had you invested it in the stock market.  That same $20,000 in 2020 would be $28,000 in 2021. And while you can’t bank on a 40% return every year (or really almost any year) the historical year over year gains of the s&p 500 for the last 100 years has averaged over 9%.

You don’t have to be rich to invest.

While purchasing stocks used to be expensive, today you can buy and sell stocks essentially for free.  And you don’t have to be an expert either.  Instead of having to know which stocks to buy and which stocks to avoid, you can place your money into ETFs or Mutual funds that track a basket of stocks like the S&P 500 or the Dow Jones Industrial Average.  Do this, and you can rest easy knowing you have diversified investments in the case of a down turn.  In todays age, you don’t even need to have enough money to purchase a whole share!  Got an extra $5? Now you can use it to buy $5 worth of a fractional share of the stock you’re interested in.

The stock market isn’t the only place to invest either.  If stocks aren’t for you you can invest your money in a variety of other options.  Want to jump into Real Estate?  Buy a rental house.  Or even a primary home for yourself.  Don’t have enough money to buy a home? You can still get exposure to real estate using options like REITs (Real Estate Investment Trust) which are companies that buy and sell or rent real estate, with the benefit that REITs are publicly traded meaning they are very easy to buy and sell, much like stocks). Otherwise you could jump into investment platforms like fundrise. Fundrise crowdsources investment money to then buy real estate properties.  The cool thing about fundrise is you can pick and choose which buildings you invest in.  The downside, is that its hard to sell your ownership once you invest.

If you don’t want to jump into real estate, there are also peer-to-peer lending platforms like prosper and SoFi. These platforms allow you to lend money to other people at interest rates far above what a bank would give you. You can usually choose how credit worthy the people are you lend to as well.  The more credit worthy, the less money you earn, the less credit worthy, the more you earn.  Be careful though, like all of the above investment options, these investments are not FDIC insured meaning there’s no guarantee you’ll make the advertised return, and there’s always a chance you could loose your entire investment.

What if I need a risk-free investment?

If there’s a good chance you’ll need the money you’re investing in the next year or two, say for a down payment on a house, you can still invest this money. Risk Free even.  While you won’t net nearly as high of a return as you potentially could in the stock market, your investment is relatively safe, even guaranteed in some instances. Even in a market downturn.  The avenues you should turn to in this type of situation would be 1)Bonds, 2)CDs, and 3)High interest savings accounts.  While Bonds are not FDIC insured, you can buy relatively safe bonds from credit worthy businesses, city and state governments, and even the Federal Government.  If you need a truly risk free investment, CDs and High interest Savings accounts are FDIC insured and will leave your investment protected.  Although beware that you’ll struggle to net even a 1% return per year on these investments depending on the length of your investment term.

 

As always, thanks for tuning in to the Savings Guy.  For the latest articles please visit my homepage

 

 

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