“How can my savings be losing value? I put them in a bank, and they are earning interest every year!” Well, this is true, but when inflation is taken account of, they are actually losing money. Inflation is easy to understand if you look back 50 years. Back in the 1960’s, you may have been able to buy a house with just a few thousand pounds – but what can you do nowadays with that much? Not an awful lot, because of inflation. The cost of everything has increased. Let’s say the rate of inflation is 10% each year, but your bank pays 8% interest on the money. If you had invested that few thousand, it would be earning interest, but since the cost of everything was increasing too, the actual value of that money in the bank – what it could buy you – was decreasing at the rate of 2% per year (10% inflation, minus 8% interest). Therefore, simply leaving money in the bank is not really helping yourself financially, at all.
As of today, the inflation rate in the UK is about 4-5%, while even the best basic savings account earn about 2% interest, with most earning only around 0.5%. It should be painfully obvious to you that if you are only earning 2% interest on your savings when the cost of things is increasing at twice that rate, you are losing out.
No, of course not. Not all of them anyway. However, if you wish to build equity and wealth – that is, to become richer – then simply putting money in a bank will not do it. Even if you work hard all your life, you could only ever hope to break even. This is the myth of saving. However, savings should always be kept around as a backup – the key is to diversify your money. If you had all of your savings in the bank, and the bank collapsed – as was the case with the recent collapse of the bank of Scotland and loss of millions of pounds – then all your money will be gone. If you split your saving up between 10 different banks, you would be covering your bases, but still only earning a basic rate of interest. The best thing to do is keep some in savings, keep some in one form of investment, and some in another etc.
The key to building worth is to invest in something that earns a higher rate of return than inflation. If inflation is 4.5%, you need to earn at least a guaranteed 5% to make that money work for you, and to build your wealth.
“But investing is risky, isn’t it?” Yes, and.. no. The rate of return that you can get from your money will depend entirely upon the risks that you take with it. If you are willing to risk the money on something that has a high chance of losing value, you may get a rate of return of 15%, or you may actually get a negative return of -5%. If you just want a safe 5% investment, there’s very little chance it won’t give that in return. You choose the level of risk you are willing to take, and you reap the rewards. Either way, you need to invest instead of simply saving.