How does the banking system work in America? From a consumer’s perspective, it’s simple. You deposit money in a commercial bank, like Capitol One or Bank of America, and they keep the money safe for you. Instead of holding stacks of cash at home, your money will show up as a number in the bank’s ledger. Whenever you purchase items from grocery stores or restaurants, you can simply swipe a credit card to initiate a transaction. Convenience is one perk of banking.
Now a problem arises when we take into account inflation. Imagine what happens when the cost of milk increases by a dollar every year, but your savings in the bank stay flat. What will happen to your buying power? In the early 1900s, you could easily buy a meal with 25 cents. Now, you can barely buy a stick of gum with the same quarter. Inflation is a phenomenon where prices of goods and services increase over time. In other words, the same $100 you have today will be valued less 5 and 10 years from now.
Ok so our money is withering in front of our eyes, is there anything we can do about it? That is where savings accounts come into play. Banks offer a variety of accounts where you can deposit money, and they will pay you additional dollars in interest. The interest rate is defined as a percentage of the initial or principal amount you provide. Let’s say a bank offers a savings account with 5% interest rate and you open the account with $100. After one year, your money will grow to $105, and $110.25 the next. Now you can safely store your money in the bank and grow its value over time.
So what does this mean to you? If you are storing significant amounts of money inside a bank account, make sure the bank is paying you interest in return! Check the interest rate on your savings account and make sure it is above the average inflation rate of 3%. Otherwise, your money is depreciating in value year over year.