Written by 7:20 pm Expats, Finance & Economics: Explained, Trending

When your savings account costs you money

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Saving money isn’t just sound advice, it’s also a great habit to have. Unfortunately, in today’s world, a savings account doesn’t always protect your cash. We examine the why, and then look at how people abroad can save their money without losing it in the process. 

If we’re all taught one thing about money at an early age, it’s this:

Save your money instead of spending it, and you’ll be making responsible decisions. 

So far, none of us at abroaden have encountered a culture that doesn’t teach some variation of this lesson. 

It makes sense: saving your money is good advice.  

Likewise, most people know that how you save your money is just as important as the act itself. 

The general rule of thumb is to stash your cash in the bank. It’s safe there, and you can access it whenever you want. 

 However, these days, savings accounts are a losing strategy.

Thanks to a few factors, our deposits lose value while we’re keeping them “safe.”  In turn, our saved cash will be worth less than when we deposited it. 

As they say in Spanish, that’s “no bueno.” 

So why is that and what can be done about it?

The best investors (and the ones who can sleep at night) invest within their risk tolerance. Do you know yours?

Why we’re losing money by “saving” it

To understand why our money loses value in savings accounts, we need to understand two concepts: 

  • Interest rates 
  • Inflation

Let’s quickly summarize.

Interest rates

The interest rate on a savings account pays you in exchange for lending your money (we’ll call this the deposit rate to keep it clear”).   

You might be thinking, “wait for a second, I’m saving my money, not lending it.”  

As it turns out, banks are in the business of lending and investing money.  They take the money deposited with them and spend it. To do so, banks will either: 

  • Lend it out (such as a mortgage, personal or business loan) to make a return later in the future
  • Invest directly in the setup of the short-term market between banks (we’ll cover this in a later post as it’s worth exploring)

Banks only have to keep a percentage of their clients’ money ready for withdrawal.  We call this amount the “reserve ratio.” The central bank — i.e., the bank of the banks — sets that ratio, as well as a minimum amount each bank must hold.  

Right so what does this have to do with interest rates? 

Banks keep their money in a central bank. Since your account is a sub-account of your banks, your savings sit inside a different financial institution.  Sorry if it’s a little bit “matrix-y,” but bear with us here.

Taking it back to the 90s here. Also, that kid has got to be at least 30 years old now. How did time go by so fast? Isn’t that the real “spoon” question?

The central bank’s job is to control the amount of money on the market (we’ll cover this topic later, too).  

Deposit rates are one of their most potent inflation-controlling tools.  If the central bank wants people to spend more, they lower deposit rates. If they want people to spend less, they raise the deposit rate. 

Your bank will pay you the central bank’s deposit rate, plus (sometimes) a small premium to say thanks for letting you use their money.  They then lend their money out at a higher rate, making a bit of a profit at the same time. At least that’s the gist of it. 

Inflation

Inflation is the increase of goods and services (i.e., stuff we buy). 

Despite its name, inflation isn’t necessarily a bad thing. Moderate inflation means that an economy is healthy.  Too little usually indicates that economic growth could be better. Too much is a sign of a mismanaged one.   

In any case, the inflation rate is an excellent indicator of how much things rise in price.  

Inflation + deposit rates = how we’re losing money

As it turns out, central bankers use deposit rates to control inflation. However, these macroeconomic gurus also have to help stimulate the economy.  Sometimes, these goals come into conflict with each other. 

As a rule of thumb, central banks want an inflation rate of 2%. When this rate is too low, they will lower the deposit rate to get money back into the economy through spending and investment. When the deposit rate goes below inflation, then the value of those deposits start to depreciate.  

In other words, in times where there is little economic growth but with the inflation rate being higher than the deposit rates, people lose money by keeping it in savings accounts. 

what inflation does to your money

After all, if you’re not beating inflation, then your money isn’t keeping up with the cost of living.  If you’re not keeping up with the cost of living, then you’re better off spending it immediately or investing it better.   

The spending part is pretty straightforward.  Investing it better? Not so much.

So what can people (expats included) do about it?

Now that we understand how savings accounts and inflation work, we can look at how to protect our savings. 

First, we need to measure what deposit rate our banks give us and compare that versus inflation.  There are a few different inflation rates we can use.

These rates take into various factors or look at specific segments.  We like consumer prices since they represent the inflation that we, as consumers, face in our daily lives.  Economists measure these rates as either the “consumer price index” (CPI) or the “harmonized index of consumer prices” (HICP) depending on where you live. 

Second, you’ll want to grab the deposit rate from your bank’s website. Generally, you’ll find this information under the different bank account features.  It’s important to remember that this rate changes periodically and is worth keeping an eye on. 

With these two numbers, the math is straightforward: 

  • If the deposit rate is higher than inflation, you’re saving money
  • If the deposit rate is lower than inflation, you’re losing money.
The impact of inflation and savings accounts. The space in red is the difference between a savings account of 0.50% and inflation at 2% for 10,000 EUR deposited 10 years ago. Ouch.

So what can be done to beat inflation?

Beating inflation gets complicated.  Since you want to beat inflation and you can’t do that in your savings account, you’ll need to look at other investment products.  

Which ones you choose and how you use them will depend a lot on your goals.  Generally, you want to avoid risky investments for short-term goals. Depending on how close you are to the goal, savings accounts could be your best option. 

Longer-term objectives such as a distant retirement can (and should) take more risk to protect against inflation.

Likewise, you should never invest in any investment that you aren’t comfortable with.  If the potential losses of that investment keep you up at night, then it isn’t for you. 

Furthermore, the CPI/HICP doesn’t apply for all goals.  Many people want to own a house or an apartment. 

As we’ve seen in the past decade, real estate in many parts of the world skyrocketed.  For people saving to buy, they would be better off tracking a real estate inflation index.

When you’re an expat, beating inflation and saving for your future gets even more complicated.  

After all, your goal could likely be in a different country than the one you’re living in. 

The difference in exchange, deposit, and inflation rates make finding the right investments (let alone strategy) enormously complicated. 

Regardless of your situation, we recommend that you speak to an investment advisor if you’re worried about how to beat inflation and protect your money.  These professionals can help you find the best strategy for your goals and investment comfort. 

We hope this article helps explain some of the mystery around your savings account. In the meantime, don’t stress too much.  Inflation is manageable, both by you and those dapper central bankers.

Abroaden is a company for expats, digital nomads and other world citizens looking for low-cost and transparent financial advice and investment management.

Note that this article is for information and educational purposes only. It does not constitute financial advice.