Investing for retirement is nothing more than a race, and your pursuer is inflation. If you stash your savings in anything that inflation can catch, you’ll only be wasting your money.
Inflation is the word people working at the Fed (with intelligent sounding titles, like “chairman”) use in place of the phrase “rising prices.” Inflation is the realization that as time goes on, things get more expensive. Hop in your time machine and go back 10 years. You’d find that gas was nearly a dollar per gallon, movie tickets were almost half what they currently are and property taxes were still outrageously high, but slightly less so than today.
(Of course, if you’ve recently thought about refinancing your home, you know that deflation is just as much a concern as inflation. But will save that for another time… :))
Why Do Savers Need to Worry About the Pace of Inflation?
Most people think savings is the opposite of spending, but this analogy isn’t really accurate. Savings is just delayed spending.
Think about savings and inflation this way. You golf every week for $22. Then one day decide that you’d rather quit golfing, save the weekly $22 for 30 years so that you can golf for 30 years after you retire. You are diligent and stash away the weekly $22 for the next 30 years, right up until retirement. The first day of being work-free, you grab your old golf clubs and head to the links. Surprise, a round now costs $65 to play. Grabbing a calculator, you realize that instead of trading 1,560 rounds of golf in the past for 1,560 rounds of golf in the future, you traded 1,560 rounds in the past for 528 future rounds.
Would anyone disagree that 1,560 rounds is better than playing 528 rounds? This is exactly how savers get burned when they invest in instruments that don’t keep pace with inflation. Unfortunately, there are a number of ways people invest that lose to inflation.
Piggy Banks and Mattresses
The first savings that inflation will catch is anything that does not appreciate in value or earn interest. That means that your piggy banks, your mattresses and the jar on top of your dresser will all lose value given time. Usually, we don’t hold onto giant hoards of money in these places, but some people have stashed away enough to buy new trucks.
Having savings is a good idea. Just make sure you are earning some form of return for it.
Most savings accounts have underperformed inflation for years. According to the BLS, inflation for urban areas is at 3%. What’s the national average for a savings account? The FDIC reports that it is only .1%.
Gone are the days where you’d simply drive to the bank and dump money in a savings account, then watch the money grow.
Certificates of Deposits
Certificates of deposit require you to surrender a certain allotment of cash for a specified period of time. In exchange, you can get a much higher rate of interest than a savings account. However, it’s not enough to cover inflation. On average, the best interest rate you can get is a 5-year CD for 1.91%.
Money Market Mutual Funds
Money market funds pool investor money in order purchase the best paying short-term financial products. It allows investors to earn the highest rates of interest being paid through savings and CDs. The problem is that these funds also tend to come with fees. The average return last July was .04% annually.
You may not be able to stop using money or savings accounts. However, if you have a pool of cash sitting around, you might want to think of a better place to store the money than under your mattress.