Why A Savings Account Actually Loses Value Over Time

If you want to save money long term a savings account is not the way to do it. In fact, over a long period of time, money in a savings account will actually become less valuable. Why is that? Because inflation is usually higher than the interest you earn on a savings account. Inflation is not a steady percentage as it fluctuates in a rather unpredictable way. But on average you can count on about 3% inflation per year. Any investment that doesn’t return at least 3% per year is actually losing you money.

Right now we are actually in a very strange time economically. The United States is experiencing deflation (meaning money is actually becoming more valuable) at the moment. But do not expect this to last. You should also not really consider it a good thing (although it may appear pretty nice when you see prices dropping) because deflation is an indicator of great economic turmoil (see The Great Depression of the 1930s.)

If you are just putting money away for a year or so and you absolutely have to have that money available to you then a savings account may be  a reasonable choice but for any period of time longer than a year I would invest my money elsewhere.

“Where Should I Invest My Money?”

This is a big question. It depends on a lot of factors, here’s some of them:

(1) How much risk tolerance do you have?
(2) Do you need to be able to have immediate access to your money “just in case” ?
(3) How long until you plan on taking your money out of this investment?

Generally, if you have low tolerance (meaning you just can’t stand to see the value of your money go down ever) or you need to have your money “just in case” or you are making a short term investment then you should choose a more safe option such as an online savings account at ING Direct or Dollar Savings Direct. Unlike your local bank savings accounts, these tend to give you a (slightly) better than inflation return. You won’t get a big return but you will beat inflation and you’ll be able to access your money if you need to.

If you are looking at a more long term investment period yet you are very adverse to risk then I think a low risk mutual fund would probably be your best bet. When looking into investing in a mutual fund they will give you many options including the safest (and lowest return) option. This may also be a good choice if you are investing for the short term. For example if you are retiring in 5 years you probably don’t want to risk your life savings on a high risk mutual fund that may go down 50% during that time. If you want to play it even safer then you can invest in a CD.

Generally the more risk, the more reward. If you are young and looking to start saving for retirement early then I would recommend high risk high reward investments. Why? Because over the long term you are likely to get a much better return on your money with this approach. Like I just mentioned, if you invest in mutual funds they will give you options ranging from “low risk/low return” to “high risk/high return” and if you are say, 30 years old and planning on retiring at age 65, I would choose the high risk/high return option. Over the course of 35 years this could make a huge difference in the amount of money you have available to you at retirement.

Obviously choosing where you want to invest your money is a big decision and I hope you will continue to research on this topic before making your decision as it is a very important one. But I do hope that you now know that a savings account at your local bank is definitely not the right answer.