Eating Away at Donuts, or Why Putting Cash under the Mattress is a Bad Idea

Saving money is great. It can provide a solution in the event of unforeseen expenses. (It’s good to have some money saved up when your car breaks down.) Saving money can also provide for realizing a goal, like a down payment on a house, or income in retirement. Few can argue that savings money is a wonderful thing.

But, it’s not just about savings money, but how you save it. Savings cash is great. Cash is the most liquid (easily accessible) form of savings. Cash's liquidity is in contrast to stocks or other assets, which must first be sold for cash. Further, cash's value does not fluctuate (in the short term). This is unlike the value of stocks, which increase or decrease in price by the second.

Inflation

Unfortunately, the value of cash erodes rather consistently over the long term because of inflation. Inflation is the effect of government printing money on an ongoing basis. The law of supply and demand dictate that when more of something is available for a given (i.e. stable) demand, that value of thing decreases. Money is no exception. All else being equal, if the money supply increases, the value of money decreases.

"...the cash in your wallet decreases in value consistently over time."

Inflation makes the cash in your wallet decrease in value consistently over time. Longer timelines mean an even greater decrease in the purchasing power of your money. Inflation eats away at purchasing power, which is essentially how much stuff your money can buy. Consider an example:

It’s the year 2013 and $10 can buy a baker’s dozen (13) of tasty donuts. Next year (2014), inflation has eroded the value of the dollar, and $10 now only nets you a straight dozen donuts. The following year, your $10 only gets you 10 donuts, and on it goes.

Thanks to SOMMAI, Grant Cochrane and freedigitalphotos.net for the donut photos.

Inflation is the reason why investing your money – and not stuffing it under the mattress – is important. Money in your mattress does not increase with time. In order to preserve the value (purchasing power) of your money, you need to invest it.

Investing Your Money

The easiest – and safest – way to invest your money is by putting that money into an FDIC-insured savings account. For a little less liquidity (access to your money), Certificates of Deposit (CD) offer a higher yield – or a higher return/rate of growth on your investment. Most banks or credit unions offer FIDC-insured CDs. Government bonds offer similar safety, but even less liquidity. You can buy government bonds directly via TreasureyDirect.gov. By using TreasueryDirect.gov, you avoid any middle man who will take a cut of your yield.

Know that yields on savings accounts, CDs, or government bonds may – or may not – keep up with inflation. (Such is the case in today's low interest rate environment). In fact, sometimes even riskier, higher-yielding investments may not even keep up with inflation. The 1970s was an example of this; stock market returns were flat while inflation was in the double digits.

"...putting your money into a savings account or other investment will help the value of your savings keep up with inflation."

Proponents of the mattress strategy and critics of the above investment strategy may reference Cyprus's recent tax on existing assets. And while it is possible that the United States government may make such a move to balance its out-of-control budget, it is highly unlikely. On the other hand, the chance that the value of one's money will erode with inflation is guaranteed.

In short, putting your money into a savings account or other investment will help the value of your savings keep up with inflation. This way, inflation won’t eat away at the value of your money. Instead, saving appropriately will ensure that you get to eat away at donuts.