I want to build interest when saving money in the bank, but I don’t know if the inflation will take it down so I don’t know if I’ll be loosing money.
Money Saving Advice and Answers
I want to build interest when saving money in the bank, but I don’t know if the inflation will take it down so I don’t know if I’ll be loosing money.
{ 2 comments… read them below or add one }
With the current interest rate environment, you would be lucky to be getting .50% apy on your money. Usually the rates increases when you can commit to a term rather than keeping it in a liquid savings account.
A term account is also known as Time Account or Certificate of Deposit (CD). You are basically lending the money to the bank for a certain period of time, say 6 months, 1 yr, 2 yrs, etc. The
average rate of return on those today is about 1.5% for 1-2 years.
You may also want to consider investing in short term bond funds which are yielding about 3-4% apy. This is something you may want to talk to a financial advisor or consultant in the branch.
Inflation is under control (for now) becuase of all the unemployment and low conumer spending. I dont think you will have to worry about that for the short term.
The short answer is to identify the factors that influence how much money you end up with in your pocket, then try and get the most out of those.
The important factors are:
- interest rate (maximise without taking on unnecessary risk)
- individual tax rate (minimise within the tax rules)
- inflation rate (hope the Government keeps this as low)
- fees (depends on the bank and account chosen)
- risk (basically being comfortable enough with who to)
Rather than just looking at interest rates you need to determine the real rate of return of each option.
The real rate of return adjusts your after-tax return for inflation and will give you a truer picture of how much your purchasing power has changed while you are saving. Purchasing power reflects what you can by a year from now vs. what you could by for the same amount today.
Let’s assume the following:
Interest Rate = 9% per year
Tax Bracket = 33%
Inflation Rate = 3% per year
So your real rate of return after a year = 9% * (1-0.33) – 3% = 3%
This means your purchasing power has increased 3% above inflation in a year. Note, if inflation was at 6% your purchasing power would not have changed at all. If interest rates are lower than inflation rates your purchasing power can actually go backwards.
I’ve simplified the example above a little by assuming interest only compounded once in the year. In reality, savings accounts usually compound interest monthly – this means, as long as you make no withdrawals in the year you can actually increase your real rate of return further.
Also I haven’t taken into account fees – if you have the choice of 2 accounts and everything is the same except that one is free of fees while the other involves a cost, then the latter will have a lower overall return (i.e. you’ll have to give back some of your intterest by way of fees).
Don’t just think about the return you’re getting.
A regular savings program is good for a number of reasons:
Saving is a good habit to get into
You can build up an emergency fund incase of job loss, medical problems, etc
You can get a deposit on your firts house
There’s usually only a very slight chance of losing all your money – unlike more risky investments like business ventures, the sharemarket, etc
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