The Silent Thief

Who Steals Your Money and Never Gets Caught?

What if I told you that nearly every American uses an “investment vehicle” that in 5 years’ time results in a 15% loss.* How so? They “invest” too much in the bank.

However, you may counter with the fact that the bank doesn’t lose money and is FDIC insured, and you’d be right! You don’t actually “lose” money; rather you end up being able to purchase less with the money because of inflation. Consequently, inflation is the thief that “steals” your money and never gets caught. Let me explain…

What Is Inflation?

The United States Bureau of Labor and Statistics on their website (www.bls.gov/cpi/) measures inflation in the economy using the Consumer Price Index (CPI). On the website they define inflation as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.” Basically, they are saying that things will cost more in the future.

What’s the Big Deal About Inflation?

Inflation has an enormous impact on the economy and is closely monitored by policy makers and the Federal Reserve. Too much inflation is really bad (just ask anyone that lived in the 80s or who currently live in Venezula). Negative inflation, deflation, is even worse (just ask anyone that lived during the depression). Consequently, it’s important that you have some inflation but not too much.

Some still think they can ignore it, but whether or not you care to know about inflation you will be directly impacted by it. It’s a lot like the weather. You may not know the cause of the weather but you will feel its affect.

Consequently, inflation is always a factor we consider with clients’ financial plans.

Whether or not you care to know about inflation you will be directly impacted by it.

How Bad Can Inflation Be?

Over time it’s effect, like the weather, is significant. Since 1950 inflation (CPI) has averaged 3.41%* per year. That means the prices of goods and services you purchase increase 3.41% each year on average. Using the rule of 72, (see my previous blog https://www.betterplanningbetterlife.com/blog/the-rule-of-72), things you purchase every day will double in price in approximately 21 years. If you live into your 80s you will see prices double 4 different times!

Why Inflation is a Good Thing

Believe it or not inflation is actually a good thing because it is a natural consequence of a growing economy. As an economy grows, there is more money. As more money is spent, there is more of a demand for goods and services, and their prices will increase.

The Dark Side of Inflation

While modest inflation is an indication of a growing economy, the dark side to inflation is that any money that isn’t growing or growing appreciably won’t be able to buy as much in the future. Here’s a simple example from my own life: When I earned a dollar for delivering papers as a kid in the early 1980s I could purchase 4 chocolate bars. However, if I decided to save that dollar in my piggy bank until the year 2021 that same dollar bill could only purchase a single chocolate bar today. For all of us that are old enough we’ve seen inflation manifested in the prices of many of the things we buy (food, energy, real estate, stamps, surfboards, etc).

The Silent Thief

For those of us that leave too much money in the bank inflation is “stealing” a little bit each year. Now while the “thievery” is silent it steals far faster than one may think as the math will show. If you have $100,000 in the bank and right now it earns 0.04%, (which is what many of the banks are currently paying), and we subtract that from the increase in the costs of goods and services, 3.41%-0.04%, we get a 3.37% decrease each year. Using our compound interest formula: Future Amount = Principle(1+interest rate)Time

=$100,000(1+(-)0.0337)5

=$100,000(0.9663)5

=$84,248.06

Now in 5 years if the bank told you that they lost over $15,000 of your account you’d be ticked and take them to court. Instead, your account shows that you have slightly more than $100,000 but what you could have purchased 5 years ago for $100,000 would now cost you more than $115,000 instead…OUCH!

Why Inflation Cannot Be Ignored

The average American retirement lasts 20 years. With inflation at 3.41%, prices of goods and services will double once during an average retirement. However, you figure that you won’t spend as much in those later years because you won’t be traveling as much. Unfortunately, that has been demonstrated to not be true by current retirees since most of your standard costs will increase at the rate of inflation (food, energy, insurance, etc). Additionally, other costs will increase much faster than inflation such as healthcare which increases around 6% a year (prices double every 12 years at this rate). Any savings in reduced spending on travel will be more than accounted for in increased spending on healthcare, and the older you become the higher the odds that you’ll be spending more money on healthcare.

What Should You Do If You Have Too Much in Cash?

First let’s define what too much cash means.

Too much cash is having more than 3-6 months’ worth of expenses in the bank. I recommend three months’ worth of expenses in savings if both partners work.

You will need between 4-6 months’ worth of expenses if you are single or just one partner works, as you only have one income to rely on. For more on emergency funds see my blog entitled In Case of Emergency… here: https://www.betterplanningbetterlife.com/blog/in-case-of-emergency.

When It Makes Sense to Have More in The Bank

If you have some large expenses in the next few years, such as saving up for a down payment on a house/rental property, a remodel, a sweet classic VW van, or you are planning on paying for your child’s college/wedding - you’ll want to keep that money in the bank. While inflation will negatively impact the dollars, it will be safe and that’s more important over the short term. However, I would recommend you look at online bank accounts (allybank, marcus, capital one) who tend to offer much higher interest than your typical brick and mortar type banks. A short-term CD can be an option as well.

When It DOESN’T Makes Sense to Have More in the Bank

If your emergency fund is too large and you don’t have some significant expense you are saving up for, you may be much better off investing this excess money instead. Historically, in terms of beating inflation stocks have been better than bonds and other investments over the long term. If you are still apprehensive, you can pursue a dollar cost averaging strategy (see my blog entitled The Best Time to Invest: https://www.betterplanningbetterlife.com/blog/the-best-time-to-invest) and invest the excess over a year or less. 

For some clients with excess cash, or who are funding a goal around 5 years away, we pursue an allocations strategy in which approximately a third is invested conservatively, another third is invested moderately, and the final third is invested aggressively. Adjustments are made in accordance with individual risk tolerance. This segmentation strategy should help mitigate against any near-term volatility while also benefiting from positive market developments as well.

Thanks for taking the time to read this blog. I hope you found it helpful. If you would like to discuss any of the above, please feel free to reach out.

* CPI inflation calculator - https://www.in2013dollars.com/us/inflation/1950?amount=1

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The hypothetical examples listed above are not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing. Investing involves risk including loss of principal. No strategy assures success or protects against loss.