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Inflation - and why you shouldn't put your money in a savings account

Every now and then I come across an article that is so important, that I just have to share it with you.

Susan Edmunds wrote this article in Stuff - and I thought it the nail on the head.

So this blog post is really just sharing it with you!

Here's why you shouldn't put your money in a savings account

SUSAN EDMUNDS

On-call savings accounts at the main banks are paying as little as 0.1 per cent a year in interest.

If you have money sitting in a savings account or bank term deposit, watch out: Its value may be eroding every day.

New Zealanders have $84 billion in New Zealand bank savings accounts and another $175b in term deposits.

Many people opt to keep their money in the bank as a way to protect it. Unlike investments in shares, the value of your bank account does not wobble when the stockmarket does.

But if you don't plan to use the money for a couple of years or more, inflation may do more harm to your savings than any sharemarket dip could.

With interest rates still at record lows, the amount that you can earn on your savings usually does not keep up with the increase of inflation - meaning each year, your money is worth a little less in real terms.

READ MORE:
Billions in savings accounts being eroded by inflation
Few bank savings accounts beat inflation


Financial adviser Liz Koh said people who wanted to use the money within five years should be in a safe product such as a bank deposit.

But if it was not needed for five to 10 years, they should be in a balanced fund. With a timeline longer than 10 years, they should turn to growth.

That would give them returns that were about two-thirds better, she said.

David Boyle, group manager of investor education at the Commission for Financial Capability, agreed bank savings accounts were not a good long-term solution.

"People don't see inflation but it's there eating away at your buying power. If you put $100 under your mattress and left it there for three months it would still probably have the same buying power and would buy what $100 would buy today.

"But 15 or 20 years later that $100 will still look the same but its buying power will be significantly lower."

On-call savings accounts at the main banks are paying as little as 0.1 per cent a year in interest. Savers can get up to 2.5 per cent if they make no withdrawals and have a couple of thousand dollars set aside. Term deposits offer interest of more than 4 per cent, but only to people who can lock their money in for five years.

Christian Hawkesby, head of fixed income at Harbour Asset Management, said the rules of term deposits had become more stringent recently.

New Zealanders have $84 billion in New Zealand bank savings accounts and another $175b in term deposits.

"I don't think that people really understand that term deposits are not a liquid investment.  They are effectively lending their money to the bank for a fixed period, and the bank is not obliged to pay them back early," he said.

"For a long time, banks let their customers break term deposits if they wanted their money back early, as a way of maintaining a good relationship. However, new regulations post-global financial crisis mean that for banks to count term deposits as a stable source of funding for regulatory purposes, then they are not allow to let term deposits be broken early – unless there are exceptional circumstances."

He said that meant people needed to think carefully about what they did with their savings.

"If they place some value on having access to their investments at short notice, they might allocate a part of their portfolio in a call account at a bank or in liquid fixed-interest securities, or in a fixed interest or income fund that holds a portion of liquid securities and has daily liquidity."

Financial adviser Liz Koh said people who wanted to use the money within five years they should be in a safe product such as a bank deposit.

Jeremy Sullivan, of advice firm Hamilton Hindin Greene, said "cash in the bank" was not always the safest strategy.

If another financial crisis were to hit and banks wobbled, funds could be at risk because of the Open Bank Resolution policy.

This allows deposits of unsecured creditors, such as those with cash and term deposits in the bank, to have a portion of their funds used to prop up the bank. Those with term deposits would have to wait 32 days to get their money, to avoid a run on the bank.

"People think the bank is safe, but if we had another crisis and everyone sold shares and bonds to put their money in the bank, that could be the worst place to be."

He said the bond market could offer better returns and mitigate some of that risk.

"If you are feeling particularly cautious, New Zealand Government Bonds offer the safest level of protection and there are number of good-quality investment grade corporate bonds which offer attractive rates and most importantly, liquidity."

Koh said it was also not tax-effective to invest in things designed to produce income, such as taxed interest.

But Boyle warned that everyone should strive to have an amount equivalent to three months' worth of income in a savings account, in case of emergencies.



 

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