Keep your money in the bank

Our parents grew up with the idea that saving money in the bank could assure their wealth in the future. But is that still true today?

Disclaimer: This article is for educational purposes only and is not financial advice. Always do your own research and consult a financial advisor before making any investment decisions.

One of the main reasons people are “losing” money in the bank is due to inflation. Inflation is the rate at which the general level of prices for goods and services rises, which erodes purchasing power. If the interest rate on your savings is lower than the inflation rate, the value of your money decreases over time. This means that even though the amount in your bank account stays the same, what you can actually buy with that money diminishes.

Additionally, keeping too much money in a low-interest savings account means missing out on potential higher returns from investments like stocks, bonds, or real estate. These investment opportunities can help your money grow at a rate that outpaces inflation, ensuring that your wealth increases over time, or at least does not decrease.

However, it’s crucial to maintain a sound financial plan. Make sure you have enough funds in your bank account to cover your monthly and recurrent expenses. This ensures that you can manage your day-to-day living costs without stress. Moreover, having a separate emergency fund is essential. This fund should ideally cover 3-6 months’ worth of living expenses and acts as a financial safety net in case of unexpected events like medical emergencies, job loss, or urgent repairs.

But, how to start investing?

For those new to investing, index funds are an excellent starting point. Index funds are a type of mutual fund designed to track the performance of a specific market index, such as the S&P 500. They offer a simple way to invest in a broad range of stocks without needing profound knowledge about individual stocks or the stock market.

Index funds are popular because they are low-cost, making them ideal for beginners. By investing in an index fund, you can gain exposure to an entire sector or even the global market, which helps diversify your investment and reduce risk. For example, an S&P 500 index fund invests in the 500 largest companies in the U.S., providing a broad market exposure.

In addition to the S&P 500, there are several Global index funds that can help you diversify internationally, like FTSE Global , MSCI All Country World, or Fidelity Global.

In the past decades index funds have beaten in performances more than 80% of active investors, professionals that study and work every day in the stock market, with much lower costs. That is why our suggestion is to stick with this funds.

To get started, you can open a brokerage account and choose an index fund that aligns with your investment goals. Look for funds with low fees and a good track record of closely tracking their target index. This approach allows you to benefit from the overall growth of the market while minimizing the risks associated with picking individual stocks.

By balancing your savings with smart investments and maintaining an emergency fund, you can protect your financial future and ensure your wealth continues to grow.

Example:

Let’s look at an example to illustrate the impact of inflation and the benefits of investing over a 20-year period, assuming you save $200 per month, and an inflation of 2% per year.

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Example 1: Saving in the Bank

If you save $200 per month in a bank account with no interest rate and an annual inflation rate of 2%, here’s what happens:

– Total Savings After 20 Years: $200 * 12 months * 20 years = $48.000

– Adjusted for Inflation: To account for the 2% annual inflation, we need to calculate the future value of today’s money. The formula for this is:

Future Value = $48.000 / (1 + 0.02)²⁰ = $32.667

So, after 20 years, your $48.000 savings would have the purchasing power of approximately $32.667 today.

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Example 2: Investing in an Index Fund

Now, let’s assume you invest the same $200 per month in an index fund with an average annual return of 7% (a reasonable assumption based on historical stock market returns) and our 2% inflation rate.

  – \( r \) is the monthly interest rate (7% annual rate) / 12 months = 0.583% per month)

  – \( n \) is the total number of investments (20 years * 12 months = 240)

Future Value = $104.606

Future Value adjusted = $104.606 / (1 + 0.02)²⁰ = $70.393

So, after 20 years, your $200 monthly investment ($48.000 total investment) would have the purchasing power of approximately $70.393 today.

These results show that while inflation erodes the value of both savings and investments, investing in an index fund still provides a significantly higher return compared to keeping money in a bank account, even after adjusting for inflation.

Moreover, if you persist in letting the time work for you even for a longer period, the compound interest will play the main role in your growth.

Index Investing For Dummies https://a.co/d/4gogsUX