Savings Rates Below Inflation? Save Anyway
When savings rates are below the inflation rate, it's easy to think, "Why should I save? Even after the interest, I'm losing money!" But there are two good reasons to save, even in the face of a negative return. (See also: While Waiting for Rates, I-Bonds)
Both your short-term and long-term goals depend on an appropriate level of savings.
When You Need Cash, Only Cash Will Do
Your short-term goals depend on savings because only cash is cash. That is, your debts and other obligations are owed in dollars (or whatever your local currency is). Cash in the bank is what will enable you to pay your debts. Any other investment — gold, stocks, foreign currency, whatever — may (or may not) do well as an investment, but is of no use in paying your bills. The utility company will not take your tenth-ounce kruggerrand or your 50-euro banknote. They want cash.
The fact is, liquidity balances (the money you keep on hand to bridge the gap between one paycheck and the next) and your emergency fund (the money you keep on hand to cover unexpected expenses or an unexpected drop in income) both need to be in cash.
Your Long-Term Goals Need Funds Too
Your long-term goals depend on savings, because savings is what will fund your investments. But interest rates on savings below the inflation rate create the potential to start thinking that you're losing money every month, and once you do that, it's easy to delude yourself into figuring that it makes sense to spend the money "before it loses its value."
That particular delusion takes two forms.
The first is the investment delusion, where you add what you figure you're losing to inflation to your estimate of investment return. So, if you think you're a stock market genius who can earn 8% in the stock market, and the inflation rate is running along at 2%, you imagine that your stock market return would be like getting 10% better than cash.
The second is the buy now delusion, where you figure you might as well pull the trigger on any planned purchases now, since if you wait the price will just go up. (There is a particularly pernicious version of this, where you figure it makes sense to borrow money to make the purchase, since you'll be paying the debt back with cheaper inflated dollars.)
The fact is, investment decisions and spending decisions need to be judged on their own merits. The inflation rate is one factor to include (although when the inflation rate is as low as it is now, it's a pretty small factor). The return you can get on cash is also a factor to consider — but very low rates on cash actually support keeping higher cash balances. (Back when you could earn 14% on your money fund, it was worth going to some effort to minimize the cash in your wallet and pay your bills at the last possible moment, so you could keep that money working for as long as possible. When you can't even get 1% on your money, the convenience of having cash on hand tends to outweigh the tiny lost income.)
All that should have very little impact on how much of your money goes for investments or on the mix of investments you select. Your investment portfolio should be structured to support all your long-term goals — retirement, college for the kids, etc.
That's because those goals — your long-term goals — are the ones that are threatened when you imagine that savings rates below the inflation rate are a reason to spend rather than save.
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