Has it ever happened to you that you want to buy something in the future and are saving money but still can't afford it? Have you ever wondered why that happens?
The answer is inflation. Because of inflation, you are not able to buy your dream car or house or whatever it is.
Inflation
Inflation is a rise in the prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money. -- From Wikipedia. It is measured in percentage. You can find the US inflation rate since 1929 here.
You want to buy a house two years from now, for example. The cost of the house is $100,000. You have $65,000 and you decide to deposit $1500 every month for two years. After two years, you will have pretty much $102,000 (interest included). But when you go to the agent, you will see that the price of the house will be greater than your savings. So, you are not able to buy the house.
Savings account
A savings account allows you to deposit money. The bank gives you compound interest on your balance and allows you to withdraw your funds whenever you want. According to the FDIC, the national average interest rate on savings accounts stands at 0.08% annual percentage yield(APY). You can read more about savings account here.
How much money are you losing months after months?
Firstly, find the inflation rate of your country and use the percentage on the interest input box and calculate the value. Secondly, find the inflation rate of your bank and use the percentage on the interest input box and calculate the value. Finally, subtract the second calculation value from the first calculation value.
If you are curious, you could check out this link to see how I made this calculator.
How could I prevent losing money?
- Enable auto-sweep in a savings account or create a Fixed Deposit (FD)
- Index funds
- Stock market
Auto-Sweep
The term "Auto Sweep" refers to a savings account and FD combined. It links your savings account to a deposit account and confirms that any additional funds in your account that are over a certain limit are automatically transferred to fixed deposits so that you can get a better return on your investment.
Auto-Sweep behind the scene
Specify the maximum amount of money that will remain in your savings account. Any amount beyond this limit will immediately be converted into an FD, and you will begin earning standard FD returns on that portion of the money. If you ever require more money than is in your bank account, the fixed deposit money is reverse-swept into your savings account, where you can then take out whatever amount you need.
For example, MAC has $50,000 in his savings account. He sets the maximum limit of $30,000. Now, the extra amount of $20,000 lying in the bank will be converted into an FD automatically and he will start earning returns equal to an FD.
In the next month, if he deposits $5,000 in his account, his total balance would be $55,000. Since he has already over the maximum, the extra $5,000 will be added to the FD. His FD balance will now reach $25,000 overall. However, if he takes $5,000 out of his account, he will actually take it out of his savings account, which will lower his balance to $25,000 instead. But if he wishes to take out $40,000, an additional $10,000 will be immediately reversed from his FD, allowing him to take out $40,000.
Fixed Deposit (FD)
FD provides a higher rate of interest than a regular savings account, until the given maturity date. In an FD, interest is only paid at the very end of the investment period.
For example, You can create a $20000 FD for 3 months. If you want to withdraw money before the maturity date(break your FD prematurely), the bank may charge a penalty(rate varies from bank to bank) and you lose out money that could have been compounded as interest.
Index fund
An index fund is a type of mutual fund. A portfolio of various stocks, bonds, and other securities makes up a mutual fund. You get a portfolio of investments through a mutual fund, which includes a large number of securities. It allows you to make more careful investments and take on less risk.
All index funds are mutual funds, but not all mutual funds are index funds. The S&P 500, the Dow Jones Industrial Average(DJIA), and Nasdaq are an example of index funds. If you want to learn the difference between mutual funds and index funds, you can read TJ Porter's article. Be careful when you invest in a mutual fund. You can read David Rodeck's and Benjamin Curry's Forbes article as well as Catherine Alford's article on Credible to learn more about index funds.
Stock market
A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks (also called shares), which represent ownership claims on businesses; these may include securities listed on a public stock exchange, as well as stock that is only traded privately. Such financial transactions take place on official exchanges and via over-the-counter (OTC) markets that follow a predetermined set of rules. -- From Wikipedia. You can read more here and here.
Takeaways
The average interest rate on a savings account is so low that your savings won’t keep pace with inflation.
Auto-Sweep and FD will make sure that you do not lose money at inflation but they will not help you increase your money.
Index funds will beat inflation and will help you increase your money a little bit. It has less risk that's why you get little profit.
Stock market is the only way that can beat inflation and will return a greater profit in the long run.
Reference
https://www.kotak.com/en/knowledge-centre/understanding-auto-sweep-facility-for-savings-account.htmlhttps://razorpay.com/learn/auto-sweep-facility-banking-quick-explainer/https://www.nerdwallet.com/article/banking/cd-certificate-of-depositInterest rates in savings accounts are variable and can change at any time. For the latest info, visit the FDIC website