Keeping money in your bank is actually losing you money because the majority of banks often offer interest rates lower than the rate of inflation, and competing financial products that offer better rates. That’s before any fees you might get charged for line of credit interest, extra check fees, multiple withdrawal penalties, ATM costs etc. If the money lost from opportunity cost, or money earned from higher paying financial instruments, is subtracted from this, the loss of money is even greater.
Numerically, inflation rates, also measured by the Consumer Price Index (CPI), vary depending on how it is calculated, the time of year, economic conditions and who you ask. Generally though, inflation averages between one and three percent based on Bureau of Labor Statistics (BLS) records. Bank savings account rates on the other hand, offer rates mostly fractional of inflation. For example, in July 2010, several brick and mortar banks where paying less than half a percent in annual interest, whereas the average inflation rate between January and May of 2010 was 2.26 percent as per inflation data.(5)
• High yield savings accounts
Many financial instruments offer interest rates higher than savings accounts; an example of this is the high yield online savings account. These types of accounts are similar to savings accounts, but offer higher rates without withdrawal penalties or locked in savings. According to Money-Rates.com, the interest rates for some of these high yield savings accounts was in excess of 2%.(2) However, even at these higher rates, maintaining value rather than beating inflation isn’t always the best option, and can lose higher interest earnings from other savings accounts.
• Peer to Peer lending
Peer to Peer lending sites like propser.com or lendingclub.com offer rates far in excess of what banks offer through their savings accounts. The difference between peer to peer lending and banks is that your lending money to people directly rather than through a bank. In this sense you make the same lending decisions as a bank loan officer yourself and are rewarded with a higher rate if the borrower doesn’t default. Even the low risk borrowers can pay rates more than double the inflation rate.
• Investment strategy
Investment strategies involve utilizing financial opportunities that maximize potential returns and minimize risk. For those that are tolerant of some risk, investing money opens up a probability of higher earnings on savings. For example, an investor may wish to dollar cost average a blue chip high yield dividend fund while hedging with an inflation protected bonds or bond funds (3). Many different investment strategies exist that may prevent losing money in a savings account.
By keeping money in your bank, there’s a good chance you are also losing money to the forces of a rising Consumer Price Index (CPI), and lost savings or investment opportunities. There are both low and high-risk ways to gain interest rates higher than a savings account; some of these such as high yield savings account, are even insured for loss through bank insolvency.
In the case of higher paying accounts that require money to be inaccessible for a period of time, sound financial management of one’s finances pays off with higher interest rates. Savings accounts are just one way to hold money, but there are many more ways to allocate money so that it does more for you. To make the most of personal savings, identifying if the money is needed, and how much risk you are willing to take can mean the difference between half a percent and five or more percent in interest rate returns.
Sources:
1. http://bit.ly/4CnR5Z (Bureau of Labor Statistics)
2. http://bit.ly/NbZhc (Money-Rates.com)
3. http://bit.ly/aOfb6N (CNN Money)
4. http://bit.ly/wfvxD (Inflationdata.com)