The government, Federal Reserve, Wall Street, and their
willing accomplices in the media would have you believe that funding and maintaining a savings account is the way to get ahead in America. The scary truth is that those who fall for this line of government BS are doomed to a life of decreasing wealth. The sad part is most people are going to wake up somewhere near retirement age, look around, and wonder what the heck happened? Where did all the money go? The short answer is that a high inflation rate and low interest rates sucked it all up into a vortex never to be seen or heard from again.
Wait a second. Low interest rates are a good thing, right? The truth is they’re great if you’re a borrower but terrible when you’re lending and the position of lender is exactly what you assume when you “invest” in typical savings assets like a certificate of deposit, money market fund, interest bearing savings account, treasury note, etc. What attracts investors to such choices is the guaranteed rate of return, because it makes us feel just a little more secure to have that “profit” locked in.
But with a reported annual inflation rate running around 4% (the actual percentage is probably MUCH higher – we estimate about 10%), and interest paid usually well below that number, falling for the savings account trap can actually cost you money. Inflation is simply a measure of how much value the dollar has lost over the course of the previous 12 months. And when the dollar loses value, you the consumer, lose spending power. It’s like getting a 4% pay reduction each and every year. Now you see why that percentage is the magic number when it comes to calculating whether or not your investments are really making you money. Here’s the simple math:
1. If you make MORE THAN 4% on an investment, it’s profitable for you
2. If you make LESS THAN 4% on an investment, it costs you money
Granted, making something on an investment, even when it’s less than 4%, is better than making nothing, which is exactly the case when you choose to keep cash assets stuffed inside your mattress. Hopefully, none of you are doing that. This concept can be a little muddy if you’re not used to thinking about rates of return in terms of inflation. Here’s a simple example of how it all works, and how an interest-bearing checking account or money market fund adds up to nothing more than you loaning the government money and receiving nothing for for it.
You deposit $1,000 in a money market fund that pays you 4% annually.
The bank, which acts as the middleman for the transaction, turns around and uses your deposit to purchase government debt such as treasury notes. When the notes come due, the government returns the money along with whatever interest rate applies at the time. For the purpose of this example and simplicity, let’s say 4%. The bank turns around and pays you that 4%. Of course, there are additional fees involved because the bank isn’t going to lose money but, for now, let’s ignore that.
Stepping back to look at the bigger picture. An unsophisticated investor counts his money at the end of the year and thinks that interest-bearing checking account is a pretty good deal. After all, he made 4% in an anemic economy. The reality, after taking into account the effect of inflation, is that he made nothing while giving the bank and federal government use of his money for a time.
If, after pondering this, you still think traditional avenues of savings are a good idea, you might need to re-read this blog post. The numbers don’t lie! You can’t win under this system in which interest rates are set and manipulated by the Federal Reserve. The end result is that, while you might think you’re increasing your portfolio at the rate of 4% each year, the compounding effect of inflation will see to it that, no matter what your account balance says, real world purchasing power is going to be much less than expected.
When you add in the reality that inflation is actually higher than 4%, the financial future of millions of young investors begins to look positively grim. You begin to see why we’re always harping about inflation and how it’s going to unravel the best laid plans of the younger generation. The sooner you acknowledge the reality of inflation and begin to take corrective steps with your portfolio investments, the sooner you have a chance to take advantage of the real investment opportunities that still exist in America today.
The Young Wealth Team
Flickr / FredoAlvarez