Thursday, October 6, 2011

Savers Are Losers

In a previous article I described money as a faithful servant but a terrible master. In another, I stated that rich people don’t work for money. In other words, they have learnt how to make money become their servant. While money works for them, they live the life of their dreams.

I have received a lot of feedback on the articles. One question readers have asked is whether saving money in the bank is a way to make money work for you. I would like to respond to this query in this article.

You can save for different reasons. Most people save for a ‘rainy day’, meaning that they put money aside to meet unexpected expenses. Others save for school fees, to buy household items, meet customary obligations, etc. In other words, they save for consumption. They save to spend.

Other people save for their retirement. In PNG, the majority of working people save with one of the superannuation funds or savings and loans societies. Currently the law says that workers are to contribute 6% of their gross salaries towards their super fund savings while employers contribute 8.4%, for a total of 14.4% every fortnight. Some employees save more than 6% of their salaries in their super fund accounts.

A third group, and I would say a very small minority at that, save for the purpose of investment. That is to say, they save money to start businesses, purchase investment property, shares etc.

For whatever reason you save, what you need to realize is that you could be losing money by just saving it, for several reasons.

Firstly, banks charge account keeping fees. You essentially pay them for maintaining an account with them. The result is that the balance in your account drops even though you have not made any withdrawals. Your bankers will tell you how much it charges if you care to ask them.

Secondly, interest rates are so low that you could in fact not be making any money from your savings account. Current interest rates for deposits with the country’s leading bank range from 0% to 3% per year for amounts ranging from K9,999 to K100,000 respectively. Interest rates for deposits are at an historical low because of very high liquidity in the banking system.

Thirdly, the Government charges an interest withholding tax of 15% per year. This means that for every Kina you earn in interest, 15 toea goes to the Government and you receive 85 toea. It makes no sense to penalize people for saving, but that is as the law stands today.

Finally, in times of high prices for goods and services, such as we are faced with currently, the purchasing power of both the principal and interest earned on savings is reduced by inflation. The Bank of PNG has reported that inflation for the June quarter of 2011 was 9.6%, and it is forecast that inflation will exceed 10% by the end of the year and beyond.

Let us see what this means for savers. The interest being paid by the leading bank for term deposits for 12 months is 3%. If you had earned this kind if interest, and with inflation at 9.6%, your real income would be minus or negative 6.6%. You would have lost money instead of making it. It would have been like taking one step forward and three steps backwards. In the meantime, the bank would have made money using your money by lending at interest in excess of 14%.

This article is titled ‘savers are losers’ because people who save money, even in super funds, do not realize that they actually lose money by doing so – unless the interest rates they earn on their money are higher than the rate of inflation. In today’s economy, interest on deposits are actually very low, rendering it difficult for savers to really make money work for them.

Most people would say that saving money is good because of compound interest, which works as follows: You save some money which earns interest, then the interest earns interest. So it goes that money grows over time without any effort from savers. But for the reasons given above, compound interest does not work as it used to in the past. Even if the cash or nominal amount increases, the real interest income would be either very low or negative.

Given that this is the case, you would be wise to save whatever you can, then invest your savings in a business. A business is a vehicle that can empower you to either ride on or beat inflation. More on this later.

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