Is Your Money Going Backwards?

Your savings are in a super tough spot right now, with low mean interest rates and stubborn inflation conspiring to eat away at the value of your cash.

You see, consumer prices are increasing at an average rate of 2.3 per cent a year at the moment. That means you’ll be able to buy less with one dollar at the end of the year than you can with that same dollar today.

To make sure your money can buy at least the same amount at the end of the year as it can today, you need to be earning a return on it. In the case of cash stashed at the bank, you’re relying on the interest rate on your account to earn that return.

How much do you need to earn?

In tax-free world, the return on your money would need to be at least 2.3 per cent to make sure your savings are worth the same at the end of the year as they are now.

But given the tax man is going to come along at the end of the financial year and demand a slice of any interest earned, we need to factor in his slice too.

To calculate how much that is, let’s take the most common marginal tax rate of 34.5 per cent (that’s the rate of tax paid on earnings between $37k and $80k, including the Medicare levy).

When you factor in paying 34.5 per cent of the interest you earn in tax, the interest rate you need to be earning to maintain the value of your savings at the end of the year jumps to 3.51 per cent.

That’s just to make sure your savings aren’t going backwards. To increase your purchasing power over the year, you need to be making even more.

What are banks paying now?

The latest data from comparison site Mozo shows the average introductory rate on savings accounts is 3.78 per cent. That covers our little calculation.

But, unfortunately, they call them introductory rates for a reason; they don’t last. What we want to look at is the average ongoing interest rate on a savings account, and that comes in at a lowly 2.49 per cent.

So, if you haven’t already, now is the time to log into your online bank accounts and see exactly what rate they’re offering. If it’s below 3.51 per cent and you’re in that middle tax bracket, the purchasing power of your savings is deteriorating.

What can you do about it?

There are limited investment options for small savings balances, but there’s still a good chance you can be doing better than your current account.

Here are three ideas.

  1. Shop around other banks and credit unions to find a better rate. Often superior rates are offered if you make regular deposits into the account, so look in whether this is an option.
  2. Research other lending options. These could include term deposits and peer-to-peer lending, where you’re matched with credit worthy borrowers at a better rate than most banks offer.
  3. Consider investing in shares. New investment management services like Stockspot make this process very easy and affordable for share market newbies.

Image: Kenny Louie, via Flickr