I’ve met a great few people who would rather keep their money in a savings account than invest it elsewhere. Not just momentarily for a future purchase or because of uncertainty in investment markets, but long term. That is where they prefer to leave their money because they think it is ‘safe’ there.

I am puzzled by this behaviour. Some of these people in my own family have tens of thousands of dollars or more squirreled away in term deposits! Not even bonds, but term deposits paying around 2%!

I try to reason with them, but the irrational fear of losing their money in shares or property prevents them from making sound investment decisions.

Little do they realise that leaving your money in cash is a surefire way to lose all your wealth. Parking your money in term deposits is better, but you are robbing yourself of future potential gains. By my reasoning, leaving your money in cash is more dangerous than real estate or diversified share market investment!

Today my shufflers, I am going to discuss inflation and why over the course of a lifetime it will rob you of your wealth and leave you with nothing but the clothes on your back.

Inflation is the word given to describe the increase in the price of goods and services over time. What this essentially means is that your Grandad could buy a loaf of bread for 20c, whereas it now costs you $2. Over time the general price of goods and services goes up. However, hopefully people’s salaries go up at roughly the same rate or more, so everyone’s buying power increases.

Inflation, the wealth destroyer

How destructive is inflation to your wealth? Surely it is not that much right?

Actually, the effect of inflation can be financially debilitating.

If you have $100,000 today and stash it under your mattress for safekeeping until you retire, it will buy you remarkably less.

How much less?

Let us look at a time frame of 37 years, from 1980 until 2017.

Let’s assume I retired in 1980 and decided to keep $100,000 of my money locked in a safe in my house.

Over the course of 37 years, the real buying power of my money would decrease to just $23,090! (1980 dollars). Over 37 years I would have lost 77% of my wealth, while under the misconception that I was keeping it safe!

For anyone planning to attain financial independence and retire early, this is not ideal.

Thankfully, there are easy ways to fend off the threat of inflation to your wealth.

Beating Inflation

If you are saving money, you need to guard your wealth against the effect of inflation.

Now let’s instead assume in 1980 I took all that money ($100,000) and put it in term deposits, reinvesting gains minus tax payable in subsequent term deposits. In this scenario my $100,000 will have turned into $158,589!

Wow that is quite abysmal, I would have not even doubled my money in real terms over the course of 37 years. However at least I would have offset the nasty effect of inflation on my wealth.

But investments can do far better than that!

Let’s say I took the ‘risk’ of share market investment. Buying a diversified ETF or parcel of shares that closely tracked the Australian share market and reinvested all dividends.

Wowza, my money would have grown over 10x!

In that scenario, my $100,000 will have grown in real terms to $1,006,688!

Given the insanity of Sydney real estate and the recent flurry of economic leaders who are finally acknowledging the presence of a bubble, real estate in Australia, particularly on the east coast, is currently only an option for the incredibly brave or the incredibly foolish.

Considering the wealth destroying effects of inflation being ever present, I’m putting my money in the ‘safest’ environment I know of right now, the share market. I’ll continue down the rentvesting path I advocated for before and I will ride out the economic waves that come with it.

Shuffling against inflation.

Pat the Shuffler

Edited 11/04/2017. Upon suggestion from a reader I have updated this article to include the effects of tax.

The original article did not include the effect of tax. When included, tax drastically affects the end result for term deposits. Due to the presence of franking credits after 1987 and a large portion of share market gain being capital gains which are untaxed unless the shares are sold, the effect of tax is far less on share market investment.

Assumptions:

Tax rate of 30%.

Assume 70% fully franked dividends post 1987.

Assume share market payed out 4% of it’s value in dividends each year.

Inflation figures taken from http://www.rba.gov.au/inflation/measures-cpi.html

Average term deposit rates taken from http://www.indexmundi.com/facts/australia/deposit-interest-rate

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