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I like a safe investment as much as the next guy. But can anyone give me a good argument on why I should invest in a bond or a savings account that returns less than inflation?

It seems to me that I am guaranteeing myself to lose, if I do that. However, given how many people do this, I wonder if I am missing something.

Of course, I understand the concepts of risk aversion, but again, I can't see how guaranteeing to lose purchasing power reduces risk.

Some people argue they are certain the markets will go down in the short term, and therefore they want to hold off. This seems dubious to me, because people who say that are sometimes "holding off" for many years. Let alone the fact that it's extremely hard for anyone to predict short term market movements, even for professional (maybe especially for professionals?).

@MichaelStum makes a good point that the instant access, risk-free characteristics are good if you need the money. So let me clarify that this question is for the money you have beyond your "reserve fund".

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    Some interest is better than no interest. I would imagine that's as simple as it can get. – Dispenser Mar 5 '18 at 17:30
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    It's difficult to argue against that statement. However the question is rather why "1% savings account" instead of (for example) "equities"? – DevShark Mar 5 '18 at 17:31
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    It isn't as easy to get money from stocks, land, whatever kind of investment as it is to get money out of a savings account. – Dispenser Mar 5 '18 at 17:35
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    A 1% savings account is a guaranteed 1% (at least up to the $250k FDIC limit). Equities are not guaranteed - historically they have had a great return, but there have been several slumps. If you know you won't need the money for years, then yeah, Equities. But your emergency "Crap, Washer broke, Dog broke his leg, kid broke his arm, I need money now" fund is more safe in a savings account. – Michael Stum Mar 5 '18 at 17:38
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    Because your socket gives you no interest. And keeping your money in your socket, you risk loosing everything if you get burglared. – user45830 Mar 6 '18 at 12:27

16 Answers 16

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Why? Because the two are unrelated. "Inflation rate" is calculated by measuring changes in the consumer price index (CPI). Your personal consumption may not match the CPI and the inflation you experience is likely quite different than what the CPI indicates. A great example of this is "rents". If rents increase, but you own your own home, does that really matter to you? It might even improve your situation if you own rental properties.

A savings account is designed to safely park money for a period of time. They are not indexed to inflation, nor do they claim to be. Assuming you have a need for a larger purchase in about a year, but you have saved the money. Your best bet is to park this into a savings account where protection of principal is an important aspect of this investment. You know when the time comes to buy, you will have at least the amount you expect. Plus you will have earned a little interest.

Given the past 12-18 months savings account may seem foolish to some, and in some cases they are. For example, why would someone keep a significant amount in savings when they are paying credit card interest? However, just because we are in a period of steady gains in the market does not mean that they will continue indefinitely. We caught a brief glimpse of this in late January, and we will have a correction in the future.

In tough economic times, a healthy savings account is a nice security blanket.

  • "You know when the time comes to buy, you will have at least the amount you expect. Plus you will have earned a little interest." Isn't OP's point that in fact you will have less money, or at least less purchasing power? Unless you assume the item you're saving up to buy is unaffected by inflation... – Jon McClung Nov 6 '18 at 0:23
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You keep money in a savings account so that you know you can access it at any point, and that it will always be there. It is diversification of risk.

If you have the money in equities instead, you can access it relatively quickly in this day and age, but it may not be there when you need it. The common example is losing your job during a recession.

If there is a recession, the value of your equities could drop 20%. You lose your job, but need money to pay the bills, mortgage, food, etc. You now have to sell your stocks at a loss, pretty much the worst time to do so.

There has not been a slump like this for almost ten years, but it is guaranteed it will happen again at some point in the future.

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    20% is tame compared to the markets dropping over 50+ pct in 2000 and 2008. – Bob Baerker Mar 5 '18 at 18:26
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Any store of value has some risk of being outpaced by inflation, as measured by some other asset. For instance, you might invest in property, but find that the cost of a loaf of bread has gone up faster than the value of property.

Wherever you put your money, you're therefore weighing up the risks and benefits:

  • The limitations on when you can put money in and out.
  • The risk to your capital.
  • The expected return above your capital, and risk of that return not being realised.
  • Your predictions on what the economy will do, and how your life will change, over the period of the investment.

Savings accounts generally guarantee your capital plus a certain return in the form of interest, and have low barriers to entry and withdrawal (the more restrictions you're willing to accept, the higher the rate you will be able to find). They are therefore a low risk place to put money in the short to medium term, because they require relatively few assumptions about the future.

What you need to compare these factors against is not some measure of inflation, but the other places you can put your money: what risk profile and restrictions do they place in order to beat the rates offered by "cash" savings? For a larger and longer-term investment, the low risk, low return may become less appealing than something which is likely, but not guaranteed, to have a higher return, and therefore give you more buying power in the future.

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Saving in a bank account that pays less than the rate of inflation isn't a risk. If inflation is 2%, and you get interest of 1%, then you will lose 1% of value per year. That isn't a risk - you know it's going to happen. Many countries have bank deposit protection schemes. In other countries, the government will step in to make sure that big banks don't go bust. So you can be pretty certain that you will get your money back.

Investing is a fund that buys shares is a risk. The fund could go up 20% over the next year. It could go down 20%. You don't know which is going to happen. If the fund does go down, nobody will step in to replace the lost money. That is a risk.

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    future inflation rates are unpredictable. ergo "inflation risk" is a risk. – james turner Mar 5 '18 at 21:56
  • Holding any asset as an investment is a liability in and of itself. Holding cash in a bank account is generally considered a low risk activity, but that would still be a gamble (albeit a gamble with very good odds), as there is a minuscule chance that the value of your fiat could potentially fall by 99.9% within the next year. By strictly numeric terms, you won't have lost anything, but in real value terms, you lost everything. – Kaslai Mar 6 '18 at 2:36
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    This answer is just plain wrong imo - inflation risk is a well-known thing and has little to do with deposit protection schemes (and note even those are an additional risk). – Dan Gravell Mar 6 '18 at 14:15
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    On the contrary, "inflation risk" is a misnomer. Risk by definition is related to uncertainty in what the return on an investment will be. Known, predictable inflation is an important investing consideration, but it's not a "risk". Sometimes the future path of inflation is uncertain, and that creates a risk that you might call "inflation risk", but that isn't what's being discussed in this question. – Nobody Mar 7 '18 at 16:12
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Get only 1% interest as opposed to what?

If you stuff the money in a little tin box under your bed, you get 0%. Clearly 1% is better than 0%.

If you believe that the market is going to fall in the short term, then it is 1% compared to a negative percent.

Money in a savings account is easy to withdraw, normally you can withdraw it within minutes. An investment in real estate, a business, etc, can be very difficult to turn into cash. So it's 1% today compared to some bigger number months from now, which may not be acceptable.

Personally, I don't have a savings account. I keep some money in a couple of very conservative mutual funds. In good years they may grow 4 or 5% but in bad years they rarely lose more than 1%. I think of that as my "savings account", and it's where I pull money from when I need more cash than I have in my checking account. Personally I also have religious objections to collecting interest as opposed to profit on an investment (Leviticus 25:36, etc), but few agree with me on that so I'm not going to get into it.

  • Hey Jay, that sounds like a reasonable approach. Do you have a few symbols for ETFs or mutual funds that return within -1% and 5%? I want to look into that. – DevShark Apr 6 '18 at 20:46
  • Usual disclaimer than I am not a broker or securities salesman and I am not necessarily recommending these particular funds. But the funds I was thinking of when I wrote my answer are with Touchstone, TSACX, TVLAX, and TVLCX. – Jay Apr 6 '18 at 21:05
  • Great, thanks (no worries, I won't hold you to anything, but it's good to have a few pointers) – DevShark Apr 6 '18 at 21:06
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    Oh, for what it's worth, those funds were recommended to me by the securities guy at my bank, Fifth Third, when I opened the account and described the sort of fund I was looking for. Whether he recommended them because they were the best funds that met my needs or because he got the biggest commission from them, I don't know. Also that was like 15 years ago. I've put money in and out but I've never switched those funds. I have a TD Ameritrade account where I invest in individual stocks that I pay a lot more attention to. As I said, I think of this as my savings account. – Jay Apr 6 '18 at 21:09
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It's worth putting some of your paycheck into a savings account just for the sake of not spending this money and saving it up for later. Of course, this doesn't mean that it's the best investment but if it helps you from just spending the money for anything else then you already gained.

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fear and ignorance: nearly everyone has an irrational fear of loss. it's called loss aversion, and it means that most people require 2:1 odds before they are willing to take a risk. e.g. in a fair coin toss, most people will refuse to bet until the payout is double the risk (i.e. they might lose 1$ or gain 2$). interestingly, the effect is based largely on how the risk is verbally phrased. if you describe the same scenario as either "a chance to win" or "a risk of missing" a payout, people respond differently (avoiding risk more than pursuing winning). that leads to large sums of money being left in savings, because people despise the simple idea of losing hard earned dollars much more than they like the idea of gaining something complex and abstract like "inflation adjusted total real average returns".

or

arrogance: some people believe they can predict bear markets, and chose to move assets away from affected markets before the bear strikes. in isolated bubbles (e.g. just tech stocks), then an investor might move to another asset (e.g. bonds, reits). however, in the last few decades the asset classes have become increasingly synchronized, leading to the potential for a simultaneous deleveraging in all asset classes, thereby making cash the best investment (e.g. it was #2 in 2008). this asset class synchronization has recently been dubbed the everything bubble.

  • Predicting bear markets is a fool's game but you have to be oblivious not to recognize when you are in one (it took 18 months in 2000 and 2008 for the markets to lose over 50% of their value). – Bob Baerker Mar 6 '18 at 20:03
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I use a low-interest savings account for 2 reasons:

  • Liquidity. I can get my money out with few restrictions
  • Security. If I keep all my money in my current account, it may be stolen. After I've payed the bills and built up a cushion in my savings account, I transfer the excess to my offset mortgage (or investment vehicle in other peoples' cases)
  • Who/how would money be stolen from a current account? – gerrit Mar 6 '18 at 15:03
  • @gerrit: at knife point whilst walking home is the most common method where I live :-). I know that the bank is insured against such events and will reimburse customers, but I don't want criminals to get thousands rather than hundreds – Bad_Bishop Mar 6 '18 at 15:29
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    Surely what they can steal that way is limited to how much you can take out from an ATM in one go? I don't suppose they take you into a branch that way. – gerrit Mar 6 '18 at 17:27
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Even if saving account returns less than inflation, it still returns anything. A small return is better than no return. If you'll keep your money under your bed, because "banks are thieves", you'll get nothing in end effect.

Another factor is security. Keeping your money at home is putting them in danger in case of robbery or natural disaster. This is the reason people keep their savings in banks even if there are no interests, for example in Switzerland.

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Interest will compound (you earn interest on accumulated interest), but inflation will not compound (you do not earn anything based on accumulated, inflated costs of the past). This is a long-term reason why you would invest in a savings account.

This is one definite distinction between the two. But, like many of the others are saying, "Some is better than none." That is the short-term reason why you would invest in a savings account.

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Why should you invest in a bond or a savings account that returns less than inflation? Compared to what?

Compared to keeping cash at home? As others have pointed out, this is definitely a worse option. You lose based on the rate of inflation, and gain nothing in interest. At least by putting the money into savings, you are getting something. Plus, you have "guard costs" -- usually a safe, and heaven help you if a bad guy invades your home, knows you have a safe, and demands you open it while threatening your family.

Compared to spending it right away? That way you get full value for your money, and lose nothing. But then you cannot accumulate your money for a major purchase, like a car or home.

Compared to stocks? A bit better, but only maybe. Stocks are speculative, and can go down for no better reason than people panic, and sell off, and at the worst possible time. Holding stocks for the long term is a bit better, but "past performance is no guarantee of future results". A major financial crash can wipe any profit and part of your principal for decades.

Compared to hard assets, like gold or silver? There is a "floor" of value that precious metals will never fall through, but precious metals are still subject to speculation. A major industrial strike in Sascatchewan (silly example) can effect the price of gold simply because people suddenly decide to move their money into something "safe" or because non-gold investments are suddenly seen as "safe enough" (and more profitable) than gold. (Silver is a bit less affected by the news like that.)

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Give me a good argument on why I should invest in a bond or
a savings account that returns less than inflation

this question is for money you have beyond your "reserve fund"

Sure!
I assume you meant "money market account" instead of "bond". Bonds and bond mutual funds generally have a return rate inverse to stocks... but that's another subject.

So, your question becomes:

Why would I use a savings account or money market when they have a lower rate of return? Excluding money for living expenses and my "reserve fund" (major car repair, job loss, etc.)

If you have a long term (5+ year) horizon, stock market mutual funds have the least risk and the most gain based on past performance. You seem to have figured this out.

Money Market / Savings accounts are useful vehicles for "medium term" investments.
You don't have an immediate/short term need, but you don't have 5+ years.

Examples:

  1. You have a child about to go to college - no matter what the economy does, you'll have that expense within a few years and you can't (won't) put it off to wait for stocks to recover.

  2. You are saving up the 10% for a down payment on a house because that's what it takes to qualify for a loan.

  3. You have a house and know it will need a new roof within a couple years and you don't want to borrow the money.

In all three of the above cases, your timeline isn't flexible enough. So... the RISK of the low return is not important when compared to the RISK that the investment will have declined in value at the wrong time.

Hope that helps

  • That's a fair point. – DevShark Apr 6 '18 at 20:48
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One benefit to me of my savings account is that in a pinch, I can get online and transfer funds to my checking account and then use its debit card. Had to do that once in another country when one card expired and another was compromised.

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The two options you're comparing are quite different and hard to compare, but one is putting your wealth into dollars and the other is taking your wealth out of dollars. (Or whatever your national currency is.)

With a savings bond or account, you're buying dollars. So you'd do that if you wanted to hold dollars.

Your question suggests the other option is to go "invest in inflation", which is not quite possible directly, but the ways you'd do it are all the opposite of holding dollars. You spend the dollars on something which is used as a basis for inflation (e.g. gold, property, grain futures), and sell it later, after inflation presumably drives up the dollar price.

As Pete B. already said, "inflation" itself is tied to the CPI, which incorporates hundreds of items, so what you buy depends on why specifically you're trying to keep pace with inflation. If the goal is to protect your ability to buy a house in a year, you probably want to hold a commodity (say, a real estate fund) that appreciates along with property values, not just overall "inflation".

You can invest in inflation-protected ETFs but their goal isn't to match inflation rates, just to hedge against inflation in general. So it's hard to really define, much less analyze, alternative to savings that your question suggests.

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This is really a question what you are optimizing: The probability of having a certain amount of (inflation corrected) value after time X follows essentially a bell curve, depending on the asset you use to store it.

While the Savings account performs bad on the median, it will outperform most other stores of value on the low end.

So when you need for example $10,000 (today's worth) in your emergency fund at any time for the next 10 years.

You may be guaranteed to have that with 99.9% probability if you put $11,000 in your savings account now.

To get the same kind of of security with an ETF for example may require you invest $20,000.

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It seems like you're comparing apples and oranges. You can't put money into "inflation", so it's not clear what you mean by comparing the interest rate of a savings account with the inflation.

In general, when you think about what to do with your money, the options are putting it into abank account, investing in equities, and investing in bonds (the investments may also be indirect, e.g. via mutual funds). And there you have a very good point: savings accounts these days return around 1%, while equities have historically averaged around 10%, and bonds are somewhere in between.

The big difference is time horizons. While equities have much better returns than savings accounts, that's only when averaged over the long term. There are often periods of time, sometimes years long, when they return less, perhaps even losing value. Stocks and bonds are therefore considered good places to park money that you don't need immediately. A corollary to this is that you should not freak out when the market takes a downturn and sell your stocks; ride it out and wait for positive returns to resume.

Savings accounts, on the other hand, are a good place to keep money for your near-term needs. Bank accounts are insured by FDIC (there are similar services for credit unions and savings & loans), so you can practically never lose your money there. Savings accounts should not generally be considered as investments; although they pay interest, that should not be your primary consideration (except as one factor when comparing among different banks).

A common recommendation is to keep enough to cover 3-6 months of expenses in your savings and checking accounts. If you have significant savings in excess of this, put it in more lucractive investments for the longer term.

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