Your Money is Losing Value – Here’s How to Stop it
Ever since I got my first job in high school working at a golf course, I would try to save every penny I made. I would of course have to spend money on gas to get there and the occasional ice cream from the shop 30 seconds down the road, but other than that I hoard every dollar in my savings account.
My friend, who also worked at the golf course with me, always asked me: “Why are you saving all your money? What are you going to spend it on?”. I gave him the same repose every time.
“I don’t know”, I secretly knew that I would know what that money was for when the time came but at that time, I had no idea. It took roughly 5 years to figure it out, but I realized I wanted to invest my money in the stock market. How did I come to this conclusion?
Inflation
The Federal Reserve tries to control inflation through the manipulation of interest rates, recently their goal has been to keep inflation at about 2% each year.
That number is an aggregate of goods and services, some might go up 1%, down 5%, or even up 25%, but on average the total price of goods goes up by 2%. On savings accounts, where I held all my wealth as a teenager, net you .01% to .5% Annual Percentage Yield.
This means for every $100 in your savings account one year from now you will have $100.50 in your account.
Although that’s not much, being an optimist $0.50 is better than nothing. That’s when I learned that you are actually “losing” money even though you gained .5%.
The reason for this is that inflation increased by 2% and your net worth only increased by .5% meaning you are losing 1.5% of the purchasing power of your money each year.
How did I combat this? I started investing.
Exchange Traded Funds
Investing is scary, you hear stories about people making millions and others losing their life savings.
Others think it’s too difficult or that it’s gambling or that they don’t have the time, therefore according to the Feral Reserve in 2019 only 53% of Americans invest in the stock market.
Investing can be intimidating at first, there are a lot of new terms and numbers and companies and ways to invest, but it really isn’t that difficult.
I started investing in Exchange Traded Funds (ETFs) these funds make it super easy and affordable to diversify your portfolio without you needing to have a lot of cash or knowledge on investing.
I invested in one of the most popular and largest ETF in the world called SPDR S&P 500 (SPY), SPY follows the S&P 500 which is a stock market index that tracks the top 500 US publicly traded companies.
The S&P 500 and SPY increase on average 10% every year, similar to the way we track inflation that does not mean every year it is guaranteed to increase by 10% but in the long run you will get a return of about 10%.
Beating Inflation
This means if you invest $100 into SPY a year from now you should your account grow to $110. That is significantly better than a savings account.
What’s even better though is that if inflation is about 2% a year and your money is earning you about 10% a year that means the purchasing power of your money on average is increasing by about 8% a year.
That is way better than the .5% interest rate you receive on your savings account.
Now, since only 53% of all Americans are invested in the stock market the other 47% presumably have their wealth in a savings account or equivalent, not only are they most likely losing the purchasing power of their money every year, but they are also not increasing their wealth by putting their money to work for them.
This is a large factor for the growing economic gap in our country, but that’s a topic for another time.
Compound Interest
Now what truly sold me on investing was compound interest, this is the interest you make on your money will earn you more interest which earns you even more interest.
This simple concept of compound interest will exponentially increase your wealth, the trick is time. The more time you have the faster your money will grow, start earlier not later.
Above is a chart showing the power of compound interest.
If you invest $500 a month for 45 years at an 8% interest rate (this is assuming we are investing in the S&P 500 and taking into account 2% inflation) for 45 years we will have contributed $270,000 but because of compounding interest, we would have over $2.3 Million.
It’s incredible what compounding interest can do for you; you just need to know how it works and how to take advantage of it.
The best thing you can do for your net worth is to start investing as soon as possible because the first best time to start investing was 10 years ago, the second-best time to start is now.