Your Savings Account is Costing You Money

by on February 16, 2012

If you’re one of the millions of people that uses a bank account to save money, then you’re actually losing money each month.  That’s because the rate of inflation is actually higher than the yields on savings accounts, CDs and even Treasury bonds.  Here’s what we mean.

If you have money invested in a savings account or a certificate of deposit, you are actually locking in negative real returns.  Here’s how it works.  Let’s say that you are earning 1% on your savings account or CD but that inflation is 3%.  The truth is, right now, savings accounts pay less than that and inflation is actually higher than that.  Anyway, let’s say you have $10,000 in your savings account.  After one year, you will have $10,100.  However, because of inflation, that $10,100 will only buy you $9,806 ($10,100 / 1.03 inflation factor) worth of goods in todays dollars.  That means that you are actually losing almost $200 in buying power by investing in savings accounts and CDs.  In this case, the loss is 2% (3% inflation minus 1% return).  However, in reality, many banks are Your savings account is costing you money because of inflationpaying only 0.3% and inflation could be as high as 4%, especially on the goods that the average person buys.  That means you could really be losing as much as 13 times the amount the bank is paying you for your savings rate.

Furthermore, it’s not just savings accounts that are losing money right now.  If you invest in Treasury bonds, you could also be locking in negative real rates of return.  That’s because 10 year treasury bonds are paying less than inflation right now also.

So if you thought you were playing it safe but now realize that you don’t want negative returns, what can you do to hedge against inflation.  First, you could consider buying TIPS, which are treasury inflation protected securities.  These securities guarantee a return of at least the rate of inflation, and the rates change each quarter with the published inflation rate.  Alternatively, you could buy into some diversified high quality dividend paying stocks.  There are hundreds of mutual funds and exchange traded funds that specialize in large cap, stable dividend paying stocks.  While these funds are more volatile than a savings account, they offer yields as high or higher than the 10 year treasury bonds (at least at the time I wrote this).  On top of that, you have upside for any increases in the stock price.  And if inflation gets higher, most of these companies have pricing power to pass the increases in inflation onto their customers.  That means that they are also a hedge on inflation themselves.

Regardless of how you handle your savings, this is a remarkable time in history.  Interest rates are so low that they are actually negative when compared to inflation.  This is something that hasn’t happened in over 60 years.

{ 8 comments… read them below or add one }

les March 1, 2012 at 4:47 am

It really shows you have to know what return you are making on your money, orelse you can cost yourself a lot of money.

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Bob Webster March 3, 2012 at 1:33 am

Yes, it’s really hard these days to find a good place to put your cash. CDs, Treasurys… they’re just not paying anything…. Dividend stocks are gaining popularity again. You can get 3% or more from solid companies that have been increasing their dividend payouts for years, if not decades.

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Terry March 31, 2012 at 6:12 am

I never actually looked at savings accounts this way. But, you’ve definitely opened my eyes to something here. Now, I’m thinking twice regarding saving in banks.

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Jerri April 29, 2012 at 8:48 pm

With so many banks making so much money on overdraft these days you would think that they would switch to a better monetization method for this.

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Marri April 29, 2012 at 8:53 pm

would going for a money market account be better if the account was paying more than 3% yeild? I would really like to find one if possible and actually put money there

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Chris S April 30, 2012 at 9:14 am

A money market account with a three percent yield would be a good deal, but hard to find right now. As of today, average money market accounts all yield less than 1%. The average is actually 0.5% but you can get a little more if you have over ten thousand dollars to invest.

The other places to get 3% yield would be to buy dividend paying stocks or some shorter term corporate bonds. Of course, they are riskier than money markets, but less risky than many other investments.

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Lew Clarke July 27, 2012 at 10:46 am

Thanks for highlighting the negative returns that many are experiencing at this time of low interest rates. I appreciate the summary of alternate options. Great post.

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Caleb April 22, 2013 at 9:45 am

This is a very insightful article. Many people including myself put their money into a savings account and checking account expecting our money to be safe and earn interest. It is becoming more difficult to find a safe place for your hard earned money.

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