We hear all kinds of advice on the topic of saving money. No matter what form the advice takes, it typically centers around one main point: saving money is a good thing. I would certainly agree with that point. Whether it’s a formula of 10% per paycheck, or some type of sporadic saving as available, you certainly want some money set aside for emergencies and/or upcoming purchases. This is basic financial advice.
This post is assuming you have at least 6 months of living expenses already saved. These are funds that need to be kept liquid(easily accessible). Your primary focus on your emergency fund should not be how much interest it earns. Your primary focus should be that it is enough money and accessible. The following information applies to savings beyond the emergency fund and not held in a retirement account. The most common examples would be a large savings account, a money market, or a CD.
First, let me define my terms. When I say “losing money,” I am referring to the buying power of your money over time. In other words, if you have $10,000 saved today, will it be worth $10,000 a year from now? Does it have the same buying power behind it? I’m not suggesting that your $10,000 balance becomes $9,600 in a year and that means you are “losing money.” I am referring to the effects of inflation on your funds over time.
Two days before I wrote this article, the latest inflation report was released showing we had a year-over-year increase in the consumer price index of 3.4% from April 2023 until April 2024. Simply put, that means your money is worth 3.4% less than it was a year ago. Your $100 from last April will buy $96.60 worth of goods today. In the middle of 2022, the year-over-year increase was closer to 9%. Inflation has been extremely high since 2021, at least compared to the 4-year period before that time. We haven’t seen inflation like this since the days of Jimmy Carter’s presidency. Under our current administration, overall prices are up over 19% in less than 4 years.
What does that mean in practical terms for our discussion today? It means that if your money has earned less than 19% in the last 4 years, you have lost purchasing power with your savings account. That equals a yearly interest rate of 5%. What are the odds you’ve been getting that high of a rate in a savings account? Probably near zero. Even money markets and CDs haven’t been paying that much(at least not the whole time). So, if you haven’t been investing that money somewhere and earned at least 5% per year on average, you’ve lost money.
Your savings account probably has an interest rate between .01-.1%. That’s nowhere near the inflation rate. CD rates vary, so it may be higher than inflation today but lower than inflation in 6 months. Generally speaking, accounts that hold liquid assets are not going to keep pace with inflation. It’s the tradeoff between risk-reward. The greater the risk—the greater potential for reward. The lower the risk—the lower the reward. Savings accounts carry virtually no risk, so the reward will be extremely limited.
Bottom line: if you are saving additional funds outside of your liquid emergency fund, consider investing it in something to keep up with inflation. That is, invest them if you don’t think you’ll need the funds. Look for CD promotions or Fixed Annuity options to lock-in a guaranteed rate of return for a set period of time.
