We crave safety and want the guarantees. Saving money in a savings account feels like one of those guarantees. But there are few guarantees in life, and this is no exception.
The Numbers
For a long time, savings accounts were offering sub one percent interest rates. Many banks still do, and people don’t realize the impact it’s having on their finances.
If inflation is three or four percent that year, money in a savings account is losing that difference to inflation. For example, if inflation is four percent and a bank is offering one percent interest, that’s a three percent difference.
For sake of even numbers, $100 plus one percent equals $101. And $101 minus $4 equals $97, a $3 dollar loss. Not a big deal with $100, but when you get into the thousands, hundreds of thousands, and millions, it becomes a really big deal.
For example, one million dollars losing three percent yearly to inflation is $30,000. That’s a lot of money! Do that for a few years and you’re into six figures.
What About High Interest Savings Accounts?
High interest saving accounts are no substitute for investing, but they are way better than low interest savings accounts. Most will at least keep up with inflation, sometimes beating it.
Back of the napkin math, three or four percent in a high interest account easily beats one percent or less you often see with brick and mortar banks. Still far less than the year over year average of investments like an index that tracks the S&P 500 though (Between 10-11 percent).
High interest savings accounts are for emergency savings and extra cushion, but they are not a viable long-term investment for most people. The person who decides to keep all their money in savings might feel safe but they’ll be perpetually running in quicksand as their money will grow right around the pace of inflation, for a net of close to zero.
The Solution: Invest and Let Money Compound
It’s important to allow money to compound, and investing regularly gives it that opportunity.
After you’ve fully funded your emergency account, invest as much as possible. After a certain point, compound interest will do the majority of the heavy lifting and your wealth will expand exponentially. You’ll continue to invest but the hard work will be done by the dollars your original dollars earn.
