How To Avoid Lazy Money

And a lot of people just believe that by getting no interest they are in a less risky situation than putting it in a higher interest account with the same bank. I'm here to tell you, the risk is the same. I would like to talk about two lazy money people. While their stories are 100% true, I have changed their names for privacy.

1. Trevor is 68 years old and has $790,000 sitting in a cheque account with one of Australia's big four banks. Of course this money was earning no interest. He had just retired and was extremely worried that if he put it in an interest earning account, and the bank went under, then he would lose the lot.

Well the bank must absolutely love Trevor. They keep his money and get to use it and loan it out. However to them it is virtually free. There is no interest to pay so they can make maximum profit.

But what Trevor has not taken into consideration is that he is actually losing money each year. As prices go up, and his pile of money doesn't move, his $790,000 can purchase less and less. To give you an idea of just how serious this situation is, if prices went up just 3% in a 12 month period, and this is pretty common, Trevor would still have his $790,000, but he could only purchase what $766,300 could one year prior. In fact Trevor has lost $23,700!

So let's put this another way. This is absolutely no different than if prices for a whole year did not move anywhere. If inflation in Australia stayed at zero percent and Trevor's bank charged him a $35.53 a day fee to keep his own money in the bank, he would have $766,300 at the end of the year. The outcome would be exactly the same. If the bank did do this then Trevor would be outraged! In fact no person should be charged this amount to just keep their money safe.

But this is exactly what Trevor is costing himself each and every day he does not put money into an interest earning account. Trevor, it's time to get an account (and by the way, this is no more risky than your current one) that pays at least 3% interest a year.

2. Brian is an 18 year old who works at a takeaway restaurant. He has been working there since he was 14 years old. Each week he has always put away $100 in savings prior to purchasing anything (smart boy). Currently he has $20,800 squirreled away.

As Brian could not trust himself with the money because he was scared he might spend it, he has given the $100 each week to his Dad to put in a safe place at home. While Brain's intentions are extremely good, like most young people he has made some mistakes along the way.

The mistake both Brian and his Dad have made is not to put this in a savings account with at least some interest. They could have opened a second account that could have transferred the money online each week, but without the ability for Brian to touch it.

Let's work out what Brian has cost himself each year. At the end of year one Brian had $5,200 safely tucked away at home. But due to not earning any interest of even 5%, he could have now had an extra $129.00. He could have had a total of $5,329 in his online account.

Now let's say Brian had wised up to this situation from day one. At the end of year four he would have $23,011 saved, a total of $2,211 more than he currently has.

I want you to think about something very important. There is no doubt for a young man Brian is doing a great job. However the $5,200 he saved with his Dad the first year is not worth the same in the fourth year. Again, because prices have been going up each year the $5,200 put away drops in value.

If prices went up just 3% a year over the four years, then by the end of year four, Brian's first $5,200 could only buy him the equivalent of $4,745, as illustrated in the table below.

Year one $5,200

Year two $5,044

Year three $4,892

Year four $4,745

So while his Dad still has the same $5,200 from the first year, every year it can buy less and less. And of course this is true for all the other years as well.

But Brian has made one more error. While he was saving $100 a week in year one, in year two he should have increased this amount by inflation of 3%. His job would have increased his wages to cover inflation, so why not increase the savings?

Or to put it another way, had he increased his amount by the same as inflation, he would be saving the same amount of purchasing power in every year going forward as in year one. Had he continued to save just $100 a week he would still be saving the same dollar amount, however he would have less purchasing power than in year one.

So had he now saved:

Year one $100 a week

Year two $103 a week

Year three $106 a week

Year four $109 a week

... then at the end of year four Brian would have $24,004, a increase of $3,204 from just giving it to his Dad to hide. He would have an increase of $993 for just adding the same $100 a week over four years into a savings account.

The moral of both stories is it's best to think through your savings plan because there could be a better option than you are currently taking.