Why saving the wrong way can actually cost you money
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Saving more money is a top financial goal for many people. But here’s the hard truth: Saving isn’t a goal, it’s a process. In fact, how you save can be just as important as whether you save at all. Too many people focus on saving money without a plan to grow their nest egg. They fall victim to something known as the paradox of wealth preservation by investing in supposedly safe assets that, well, actually destroy their wealth.
##The paradox of wealth preservation The paradox of wealth preservation is a simple concept with big ramifications for how you save money. As the book Shock Markets notes, “The assets most commonly believed to be ‘safe’ stores of value actually have a track record of destroying wealth.”
Essentially, in the long run, “risky” assets like stocks almost always outperform “safe” assets like cash stored in savings accounts. Safe assets lose more value over time, and investors who look to protect their savings with safe assets are actually putting their portfolio at risk.
##The problem with savings accounts We’ve all heard the phrase “cash is king.” But when it comes to preserving your wealth, cash is actually a pretty lousy monarch. The problem? Inflation. If you’ve ever heard your grandmother reminisce about the good old days when milk cost 10-cents a gallon, you have some understanding of inflation.
The purchasing value of money declines over time. For example, $1 in 1860 was equal to $27.28 in 2015. In more recent timeframes, $1 in the year 2000 is worth as much as $1.44 in the 2017.
Let’s say you were burned by the Great Recession, and instead of investing in the market, you decided to keep your savings in cash. One dollar in January 2007 has the same buying power as $1.20 in January of 2017. By keeping money in cash from 2007 to 2017, you’ve lost 20%.
Not as safe as it seemed.
Even if that money was kept in a savings account, you didn’t earn much. Interest rates have been devastated, with many basic bank accounts offering absolutely no interest at all. These days, you’re lucky to earn anything, and beating inflation is rare.
By contrast, since the bottom of the crash, the stock market has more than tripled. But the returns offered by the stock market are so much more attractive that even if you would’ve made the mistake of investing in the Dow Jones on January 1 of 2007, and kept that investment until January 1, 2017, you would be up by 58% on paper, and 32% in real terms (after accounting for inflation).
The difference is staggering. In only 10 years, keeping money in cash resulted in a difficult 20% loss. Putting money in the stock market resulted in a major 32% real gain—even though that investment was horribly timed, right before the biggest financial crisis in a generation. An investment that was better timed, by the way, could easily have made real gains of over 200%.
##Are stocks riskier than savings accounts? Not so fast The stock market is hard to understand. It’s risky. It fluctuates and sometimes crashes. There are bubbles and bankruptcies. But despite all its problems, for over 100 years it has been one of the best ways to grow your wealth.
There is a widespread perception that keeping your money in cash is a better investment than putting it in the stock market. According to Gallup:
Before the 2008 financial crisis, 62% of U.S. adults, on average, said they owned stocks. Since then, the average has been 54%.
The same survey reports that while nearly 90% of households earning over $100,000 per year own stocks, a mere 54% of households earning between $30,000 to $74,999 own stocks. Likewise, a 2010 Gallup survey found that savings accounts were more a more trusted long-term investment than stocks—despite the fact that stocks have massively outperformed savings accounts.
Financial crises and crashes happen, but the stock market is still one of the best ways to grow your wealth. People generally understand this, but few know just how staggering the numbers really are.
One dollar invested in the S&P 500 in 1950 would be worth over $1,280 today. The effects are still huge for more recent investments; one dollar invested in the S&P 500 in 1990 is worth over $11 today. Through crashes and crises, the stock market gains and loses value. But in the long run, it has proven a remarkably strong generator of wealth.
##Don’t get trapped by the paradox To truly save money, you need to start thinking like an investor. Even preserving your savings requires beating inflation, and making your money work for you requires real returns. The stock market can offer that, while cash and low-yielding savings accounts will bleed money due to inflation.
A mindset focused on wealth preservation, instead of growth, will ultimately cost you money. We can’t predict the future, but if it’s anything like the past, then investments in the stock market are actually much safer than investments in cash.
Worried about the way you're saving? We can give you tips, but for real investment advice you should talk to a certified financial advisor? If you don't know how to find one, check out GuideVine.
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