Are you saving too much?
Surely the answer can’t be no, right? Since when would a personal finance article chastise someone for saving too much?
But the answer might be far more complicated than you give it credit for.
No matter the stage in your life, if your cash is sitting idle, you are actually losing money.
Eroding Your Savings
One of the primary factors that applies a drag on our financial well-being is inflation. Simply put, inflation is the reason that your grocery bill costs you more now than it did a year ago, for exactly the same items.
Inflation is a very complex mechanism, reflecting the changes in prices over time. And it’s not news to us. Everyone’s grandparents have a story where a fist-full of candies only cost a quarter at the corner store. These days, that same fist-full will cost you a tenner easily.
What it does mean though, is that stockpiling cash that you earn today will allow you to buy less in the future.
Why Are Prices Changing (Again)
Inflation is caused by a combination of different factors. The first of which is simply based on expectations. Everyone believes that the same services will cost more next year than they do this year.
I see this all the time in my work at a software company. Each of our contracts provides for an annual uplift, so the $100 cost this year becomes $105 next year. This is the same reason that your phone bill increases year after year. You aren’t necessarily guaranteed better cell reception, or faster speeds, but your price increases nonetheless.
The next factor behind inflation comes from the input side. When the costs to make a product increase, those increased costs are passed onto the consumers through higher prices. And there are limitless reasons for higher input costs. Higher gas prices, increased shipping costs, minimum wage hikes, etc. all play a role in making products more expensive to make. Costs that inevitably get passed onto the market.
The third element that impacts inflation comes from the other side, the demand side. When more people want to purchase something than supply can accommodate, the price goes up. That’s why when the lumber mills shut down for COVID (supply reduction), the cost of lumber skyrocketed (demand outpaced supply). We see a similar situation with computer chips as well, with the secondary market reselling for far above an already inflated sticker price.
When Treading Water Isn’t Enough
What does all this mean? Well, it means that when you save a dollar today, it will buy you less in the future. How much less depends on inflation.
If the government was able to effectively influence inflation, that dollar would be able to buy 2% less each year.
But this past year has been anything but normal. July 2021 statistics released by the Bureau of Labor Statistics show that the same basket of goods has increased in cost by 5.4% in the last 12 months.
Let that sink in for a moment.
If you have extra cash sitting in a high interest e-savings account, like what I recommend for your emergency fund, that cash has effectively lost 5.4% of its value in the past year alone! Even if you are incredibly lucky to still be earning interest, you’ve likely still lost 5% of your purchasing power in the last year.
How To Stay Afloat
If losing 5% for diligently saving seems scary, it should be!
Having too much extra cash sitting in your accounts is actually costing you money. If you want to have a brighter financial future, you need that extra money to go to work for you.
In the same trailing twelve months (TTM) ending July 31, 2021, the S&P 500 index increased in value by 17.99%. After inflation, that’s still a whopping 12.59% return in the same period!
This week, run the numbers. Do you have too much cash sitting in your accounts?
Make sure you’ve got your near-term purchases funded, and some cash set aside for your emergency fund. If there is anything leftover though, make sure that cash is working for you. Because the alternative is slowly bleeding that savings account dry.
Investing can be risky. But it’s far less risky to do something than to be eroded down to nothing from inaction. Mitigate the risk by buying a market index ETF, and put those extra dollars to work for you, so that one day you don’t have to work for your savings.