So I have a very good friend, Nick Rosson, who is a dual degree undergrad (econ and chemistry) that decided to drop out of a doctoral program in chemistry to pursue a career in finance (overall point: he's fairly bright). He and I love to talk finance and investing (though, truth be told, it is more so him talking and me gleaning as much information as I can out of the conversations. Needless to say, I wish I had more money to invest....) and I thought the conversations warranted our sharing some thoughts.
Since he has some great ideas about what is not only wrong with our current economic climate, but also what the average American can do to gain a slice of the ever growing pie, Nick has written some blog posts (NREconBus.blogspot.com) that I rewriting here (as much to promote his ideas as to tone down what I feel is a lecturish format). Know that I am not giving you info out of my own mouth (as I am certain many of you would wonder what in the world I know about finance), rather I am rewording from a very informed source.
The first conversation we'd like to have is about saving accounts, specifically how investing through them is actually costing you money every year. Yes, you read that right, having money in a savings account is actually causing your investment to depreciate in value every year.
(HUGE DISCLAIMER: I - and on behalf of Nick - want to stress that ALL investing means ownership and understanding of inherent risk)
How Banks work, just not for you:
Banks operate as the middlemen in our world, matching buyers and sellers while making sure to take a rather generous cut for themselves for their efforts. Though the buyers and sellers vary depending on the product, most times the sellers are the common American hoping to save a few bucks (for a rainy day fund, that new car, or a down payment on a new house) and who do so by putting their money into savings accounts. Banks collect and then pool all of this money by offering people interest on their "investments" (usually somewhere in the realm of .01%). The bank then turns around and loans this money out to buyers (usually those same Americans looking for a loan to cover any shortfall they may have between what they have saved and what they need to purchase their dream) at an interest rate somewhere in the realm of 5%-15% above and beyond the principle.
(Quick lesson, just in case: Say you take out a loan of $10,000 to buy a used car. This amount is now your principle. If you are charged 5% (a "good" interest rate) you will be expected to pay $500 per year in interest should you never make payments (principle now becomes $10,500 after year one). Every time you make a payment interest is paid off first, then the remaining payment (if any) goes towards your principle. Since most "minimum payments" rarely go above what is owed in interest every month, those people paying only the minimum usually notice that their principle amount rarely changes.
What seems like a fantastic idea on the surface, having a place to "save" money for say a 2014 15" retina MacBook Pro, actually turns out to be a bit of false advertising. Though convinced that banks are great places to safely save for a purchase we foresee making in the next six months to a year, the only thing a bank is truly good for is storing a catastrophe fund (three to six months of bill should something catastrophic happen to you or your family). What's worse is that many people actually are lured into believing that savings accounts are not only the best way to invest, but often the only way. This is almost always untrue, especially long term.
To show why, first we need to understand a little bit about our economy and the banking system. As mentioned before, banks pay people an incredibly nominal amount to "save" their money in their institutions. This amount is your interest rate. Let's say that you have a fairly good amount of money in your savings account and you qualify for the highest interest paying account (It appears for Wells Fargo that amount is: a minimum $100,000 to receive a 0.05% Annual Percentage Yearly and Bank of America: min $250,000 for 0.04% - Please keep in mind that the AVERAGE savings account pays less than .02%).
Using the Wells Fargo data, since it pays slightly more, and based on the calculator found here (https://www.bankofinternet.com/calculators/apy-interest-calculator), we can run some values. For kicks and giggles, lets just say we all have an extra $100,000 which we invested in 2009 through Wells Fargo at 0.05% over a five year (60 month) timespan. Using the compounding daily option (this means getting interest on a daily basis, which, to be fair, is VERY optimistic) we can calculate that, in five years, our $100,000 would be worth $100,250.31. That seems pretty fantastic; you've made just over $250.
Remember when we told you that banks are actually costing you money....? Well, this is due to inflation, a factor of economics that is essentially "set" by our nation's top bank, the Federal Reserve. Though how it is done is beyond the scope of this article, know that the Fed currently tries to keep inflation at about 2% yearly.
This means that, every year, your money actually loses 2% in "buying power" (means that what was once say $1 costs, a year later, $1.02). For an example, and in comparison to our $250 earned over our five years of "saving", let's say you had put that $100,000 in your mattress in 2009. Using the calculator here (http://data.bls.gov/cgi-bin/cpicalc.pl) we can see what inflation, over the course of five years, has done to the buying power of our money. As you can see, that $100,000 now has a value of $111,096.45. Though this sounds awesome, what this shows is that what you could have bought for $100,000 in 2009 (cars, groceries, gas, clothes, electronics, etc) now would cost you $111,096.45 due to inflation.
And therein lies the problem. While you "saved" your $100,000 from 2009 and added $250.31 in profit, by the time you actually want to use it your money is actually worth $10,846.14 less in 2014 dollars. You are actually significantly worse off saving your money in banks, and the $250 you got from the bank is only slightly better than saving it in your mattress!
So, the question becomes, why do so many people invest in banks, and what are the alternatives? The answer to the first question usually surrounds safety (ironically maybe the only justifiable way to call them "saving"s accounts) in that, so long as the global economies don't crash, your money (up to $200,000 per institution) is protected. With the volatile market, many people don't want to take the risk of the stock market.
There are however, many "safer" options, namely CDs and money market accounts that have a higher paying interest rate than a bank. To truly get ahead though, you must start to look into bonds for a small, real return (greater than inflation), or stocks and mutual funds to actually generate profits.
If you want to never think about it, to trust that your money will always be there, go ahead and keep it all in a bank, just know that "saving" money in a bank is only making one person money, and that person is not you. If you want to start to delve into the world of actual investing, we will begin, over the course of a few articles, explain a little more clearly the world of investing and finance.
If you are truly nervous to do it yourself, ask around within your friend groups, we can guarantee there is at least one who has a lead on a good financial manager or advisor. Though the idea of giving 1% of your investment to someone may seem contradictory, when they return 5, 8, even 12% or more, 1% becomes nothing (especially since you are making far more than .02%).
