If you're assured something will come to pass, it's said to be "money in the bank." The term signifies reliability or a guaranteed win. Unfortunately in an era of low interest rates and high inflation, which is where we are today, the only guarantee you get with having money in the bank is a loss of purchasing power.
I'm going to explain why you shouldn't park all your money in savings accounts, CD's, cash and other risk-free assets. This is true in almost every financial environment, but it's especially true today.
What Is a Risk-Free Asset?
A risk-free asset has a certain future return and virtually no possibility of loss. Debt obligations issued by the U.S. Treasury are considered to be risk-free because they are backed by the "full faith and credit" of the U.S. government. The Federal Deposit Insurance Corporation (FDIC) insures up to $250,000 in bank deposits and CDs.
The first step in achieving your financial objectives is to understand your goals. Short-term goals have a time frame between three months to two years. Medium-term goals are between two and five years. Long-term goals exceed five years.
Examples of short-term goals:
Saving for a car down payment
Saving for a wedding
Saving for a vacation
Examples of long-term goals:
Saving for retirement
Saving for a child's education
However, the convenience and safety of savings accounts and other risk-free assets isn't really risk free. The price you pay is a loss of purchasing power called inflation risk.
What is Inflation?
Inflation is an economic phenomenon where prices on goods and services rise, either because of increased demand or short supply and is a direct result of central banks printing lots of money. If the prices on food, gas, and clothing rise, but you're still paid the same salary, your money can't buy as much. If the price of a can of soda rises from $1 to $2, your $10 soda allowance can now only buy five cans instead of the 10 you previously could.
Currently, all risk-free assets earn practically nothing.
With yields this low, if your money isn’t working for you, it’s working against you! Yield is the earned return described as a percentage of the initial investment. For instance a $100 annual return on a $1,000 bond has a 10 percent yield.
The federal government's Consumer Price Index (CPI) measures the rate of inflation. The CPI rose 5.4 percent over the 12 months ended June 2021.
Meanwhile, the best interest rate paid on savings accounts is 0.55 percent, according to Bankrate. That yield is one-tenth the rate of inflation. And the national average, according to Bankrate, is a mere 0.06 percent, one-hundredth the pace of CPI growth.
If you park $1,000 in a savings account with a 0.06 percent yield, at the end of the year your return is a measly 60 cents. ($1,000 x 0.0006 = $0.60)
Excuse me if I'm not all that excited by that opportunity.
Even the best CDs, which pay higher interest rates than savings accounts, are yielding just 0.8 percent, as mentioned in my previous story CDs vs. Bonds.
The reason these rates are so low is because there’s no risk in lending to the bank or the U.S. Government. If you put your money in the bank you WILL absolutely get your money back. The FDIC guarantees it.
One alternative to putting "money in the bank” is to bury it in a hole in the backyard or a mattress. That literally pays you nothing.
So, while money in a CD or savings account is definitely better than a hole in the ground, you still suffer inflation risk. Your money isn’t working for you and your buying power is declining!
Highlights of savings accounts:
Convenience and risk-free nature means lower interest rates are earned.
If inflation is higher than your return, the value of your money goes down in terms of what you can buy. Inflation has recently been running very high - substantially higher than risk-free rates.
Make Your Money Work 4U not Against You!
So, how do you increase your return on the money you worked so hard to save? Buy bonds.
If you're willing to learn with us, we will find yields that can make a material difference in your life. Those higher interest rates are found in bonds.
In order to earn more money you must accept risk. But what is risk and how much can you handle?
Risk is the potential for losing your investment.
The key factor in risk is how much of it are you willing to tolerate and still be able to sleep at night. A bond is a loan to a company or municipality. How do you feel about lending money to your state government, or Tesla, or Goldman Sachs?
Understanding your personal appetite for risk is the key to making your money work for you.
To be clear, putting money for your long-term goals into a savings account is counter productive and will detract from your wealth accumulation. Investing your money in bonds will help you keep up with inflation and accumulate wealth.
It's time for you to take personal responsibility over your money and earn multiples of what’s available in the risk-free world. It's time to explore buying bonds directly.
We're simplifying the process of purchasing bonds to offer investors easy access to the bond market. We're building Arthur as a community, so that together we can learn how the $50 trillion bond market can be harnessed to fund our future cash flow needs.
1. Owning a bond directly offers you the choice and flexibility of finding something that fits your investment horizon, goals, values and social preferences without the management fees and other costs of a bond fund.
2. Owning bonds directly allows you to receive your interest as cash on a regular basis.
3. Owning bonds directly means that when a bond matures, you get your money back.
Arthur will make bonds accessible to everyone.