Dime Finance

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Understanding Inflation

A lot of people suggest that saving money and cutting back on luxuries is the path to wealth. Even the legendary Warren Buffet seems to agree– he claims to eat only a homemade sandwich for lunch.

This line of thought has a few unstated assumptions included in it:

1. Money saved in a bank will accumulate interest at a rate greater than inflation
2. Saving money is the safest form of investment
3. Skimping on luxuries will eventually “add up”

This article suggests that a combination of saving money via cutting back, being cheap, and using the “saved” money on stocks can supplement a normal income, eventually allowing the investor to be “rich”. I’m not sure this is true. The two previously stated assumptions have some problems with them.

First, money saved in a bank has no guarantee of growing faster than inflation; with interest rates extremely poor and often jerked around by banks at will, there’s no way of knowing whether the rate you signed up for will persist. Second, though a true savings account wouldn’t have this problem, saved money is subject to various fees that the bank insists upon. These fees can quickly add up and take a major chip out of your savings, given the time. Money saved isn’t money earned unless you carefully invest it and protect it.

The second assumption is technically true, but it isn’t as good of a selling point as it seems. For reasons previously stated, to call savings “investment” isn’t exactly true; the raw amount of money might be increased, but not necessarily the overall value of the money in the account. As far as safety goes, banks are not as safe as it gets; you’re handing your money over to a private entity other than you. For the ultimate safety, opt for bonds. The return on bonds is low, but the risk is negligible, except in case of extreme destabilization.

The third assumption is one that I can find no problems with. I have made this assumption a law to obey in my life. It’s hard to quantify exactly how much money I’ve prevented myself from spending by being cheap, but hopefully I’ll be able to invest the difference in the future.