Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / The Inflation Tax on Your Savings Account
Transcript
- Lucas: Luna, I want to start with a number that stung me this morning. The average savings account in the US is still yielding about 0.5 percent. Meanwhile, the latest CPI reading from April — 332.4 on the index — puts annual inflation around 3 percent. So if you have your emergency fund sitting in a traditional bank account, you're losing roughly 2.5 percent of its purchasing power every single year. Luna: Ouch. And that's not even counting what happens when you factor in taxes on that 0.5 percent interest. Lucas: Exactly. If you're in a 22 percent federal bracket, after tax your yield is more like 0.39 percent. So the real, after-tax, after-inflation return is negative 2.6 percent. That's the quietest tax you'll ever pay — no bill arrives in the mail, your balance might even go up a little, but your ability to buy groceries or pay rent with that money is shrinking month by month. Luna: And yet, a lot of people keep their emergency fund in a standard savings account because it's easy, it's linked to their checking account, and they think 'at least it's safe.' But safe from what — bank failure, or inflation? Lucas: Both, ideally. And with the Fed holding the effective federal funds rate at 3.63 percent as of May 1 — actually the daily rate ticked to 3.62 as of this week — there's a huge disconnect. The central bank is paying banks 3.65 percent on reserves, but those rates are barely trickling down to depositors. Banks are pocketing the spread. Luna: Right, that's the interest on reserve balances — currently 3.65 percent. So banks are getting that from the Fed, and then turning around and offering you 0.5 percent on your savings. That's a 3.15 percentage point margin. Lucas: It's a massive subsidy for the banking sector. And the frustrating part is that you don't have to accept it. There are options that pay much closer to the risk-free rate. A high-yield savings account from an online bank is currently yielding around 4 percent — some are even at 4.25. That completely changes the math. Luna: Let's do the math. On a $10,000 emergency fund at 0.5 percent vs 4 percent over two years with 3 percent inflation. Lucas: Sure. At 0.5 percent, after two years you have about $10,100 in nominal terms. But adjust for 3 percent inflation — cumulative about 6.1 percent — and your real purchasing power is roughly $9,500. You've lost $500 of buying power. At 4 percent, after two years you have about $10,816 nominal. Adjusted for inflation, that's about $10,200 real. So you've actually preserved and even grown your purchasing power slightly. Luna: That's a $700 difference in real terms from just switching accounts. And it's not like you're taking on stock market risk. Lucas: No, and that's the key point. A high-yield savings account is still FDIC insured up to $250,000. It's still liquid — you can move money in and out same day. The only trade-off is that you might have to open an account at an online bank instead of your local branch. But for most people, that's a minor inconvenience. Luna: What about money market funds? Those are yielding a bit more right now — some are over 4.5 percent because they hold short-term Treasury bills. Lucas: That's a great option too. A Treasury money market fund currently yields around 4.6 percent. It's not FDIC insured, but it's backed by Treasuries — essentially as safe as the US government. The main difference is that money market funds are not guaranteed to maintain a $1 net asset value, though in practice they've only 'broken the buck' a handful of times. And you typically need a brokerage account to buy one. Luna: So if someone has, say, $20,000 in an emergency fund, they could put $10,000 in a high-yield savings and $10,000 in a money market fund for a blended yield around 4.3 percent. That would keep the $500 difference I mentioned earlier. Lucas: That's a smart split. It gives you the liquidity of the savings account for immediate needs and a slightly higher yield on the rest. The key is to avoid the temptation to chase yield by going into longer-duration bonds or stocks with your emergency fund. That's when people get hurt — they need the money during a market downturn and have to sell at a loss. Luna: Speaking of which, the S&P 500 is at 7,610 today, up 1.2 percent in the last five days. The market is near all-time highs. It's tempting to think 'I'll just put my emergency fund in the market and earn much more.' But that's a recipe for disaster. Lucas: It really is. An emergency fund is insurance, not an investment. Its job is to be there when you lose your job or your transmission blows up. If it's down 20 percent because the market corrected, you're forced to sell at the worst time. So the goal is to match or slightly beat inflation, not to generate alpha. Luna: Honestly, if this conversation has helped you think about your savings differently, that's the link — buy me a coffee dot com slash fexingo. The smallest possible ask, and it keeps this show ad-free. Lucas: Yeah, listener support really does make a difference. It lets us keep digging into these concrete numbers without any sponsor influence. So if today was worth a coffee to you, that's the link. Luna: Exactly. Now, back to the math. One thing that I think gets overlooked is the psychological cost of having your savings in a low-yield account. You see the balance barely budging, and it feels pointless. Lucas: That's real. If your savings account is yielding 0.5 percent and inflation is 3 percent, every dollar you save is actually becoming less valuable over time. That can be demotivating. But if you're earning 4 percent, your savings are growing in real terms, and that reinforces the habit. It's a virtuous cycle. Luna: Let's talk about one more option: Series I savings bonds. They're designed specifically to protect against inflation — the rate is adjusted every six months based on CPI. Lucas: I bonds are a good tool, but they have limitations. You can only buy $10,000 per person per year electronically, plus another $5,000 via tax refund. And you can't redeem them for the first 12 months. If you redeem within five years, you lose the last three months of interest. So they're not great for an emergency fund that you might need tomorrow, but they could be part of a multi-year savings strategy. Luna: Right now the I bond rate is based on a fixed rate plus the semiannual inflation adjustment. The latest composite rate is around 3.4 percent. That's less than a high-yield savings account, but it's tax-deferred and state tax exempt. Lucas: And if inflation were to spike again, I bonds would adjust upward. They're a useful hedge, but they're not a silver bullet. The simplest fix for most people is just to move their savings to an account that pays a competitive yield. It takes 15 minutes online. Luna: I think the biggest takeaway is that the inflation tax on cash is real, but it's voluntary. You don't have to pay it. Lucas: That's exactly right. The Federal Reserve is paying 3.65 percent on reserves. The Treasury market is paying 4.2 percent on a six-month bill. You can earn those yields with virtually no risk. The only thing stopping you is inertia. Luna: And the banks are counting on that inertia. They make billions in spread income from savers who don't switch. Lucas: So if you have cash earning less than about 3.5 percent, you are effectively subsidizing your bank's profits. And with the Fed likely to hold rates steady for a while — the effective rate has been flat at 3.62 over the past few days — there's no reason to wait. The window is open. Luna: One thing to watch: if the Fed cuts rates later this year, those high-yield accounts and money market funds will come down too. So locking in a slightly longer-term Treasury note, like a one- or two-year note yielding around 3.8 percent, might make sense for part of your savings. Lucas: That's a valid strategy. You can build a CD ladder or buy Treasuries directly through TreasuryDirect or a brokerage. The main point is to be intentional. Don't let your savings silently leak value. Luna: Let's summarize for someone who wants to act on this today. First step: check what your current savings account yields. If it's below 3 percent, open a high-yield savings account at an online bank. Second: consider a money market fund for a portion. Third: if you have a longer time horizon, maybe look at I bonds or a short-term Treasury. Lucas: That's a solid plan. And remember, the goal isn't to get rich off your emergency fund. It's to keep your powder dry so that when you need it, it's worth what you thought it was. With the S&P at 7,610 and gold at 4,505, there's a lot of market noise. But your savings should be boring and reliable. Luna: Boring and reliable — that's the emergency fund mantra. And if you're already earning 4 percent, you're ahead of the game. If not, there's a simple fix. Lucas: Next episode, we're going to look at how inflation is affecting the rental market — specifically, why rents are still climbing even as overall inflation cools. We'll talk about the 20 percent rent increase in some Sun Belt cities over the past two years. Luna: That is going to hit close to home for a lot of listeners. Until then, check your savings rate.