The Young Investor

Often, parents who are looking to instill in their child an early foundational understanding of the art of saving, will go out and buy a piggy bank for their child. It is hoped that through the act of small beginners’ savings, children will learn the importance of saving and end up creating smart financial habits for the future.

I remember my first piggy bank. Instead of resembling the shape of a portly pig, my safe resembled more of a child’s spy gadget. It was the mid-2000s and secret agents were hot sh!t. So, it was safe to say my money was being housed in style. Initially, as an 8-year-old, I had no knowledge of the economy. I saw money in the purest of sense… An object meant to collect rather than trade. Now, my parents might have hoped that I would save a bit of money to spend later. However, all my plastic bank taught me was how to hoard. At my worst, the underside of my bed became jam-packed with coins.

Sure, in a sense I thought of myself as being rich, but I never thought to use my saving to create more savings. And herein lies the problem. We as a society try to encourage kids to save in personal banks. Parents buy toy banks thinking they are teaching their children a valuable life long lesson. However, rather this act of goodwill proves more destructive than constructive. Yes, savings, if done correctly, can provide those with a nice safety net. Although, more often then not a person’s attempt at saving tends to be in a system that favors regression.

Let’s take a second to look back at the example of the piggy bank. It is true that if you place a quarter into your plastic bank and when the time comes to cash out, that same quarter will be waiting there to be spent. Or will it? Sadly your home bank is not immune to the change of purchasing power.

In simple terms, purchasing power is the number of goods that can be bought using a unit of currency. So when a gallon of gas goes up 5 cents, suddenly your purchasing power is 5 cents less. This decreased in purchasing power is attributed to the act of inflation. Inflation describes the action of rising prices within the market over a period of time.

Inflation doesn’t always mean destruction. Often, inflation is a normally occurring process within the economy. However, when inflation becomes unpredictable and uncontrollable, then a problem arises. But if one is able to factor inflation into the exchanging of goods, then inflation suddenly becomes more manageable.

Do you see the problem? A personal home style bank has no way of correcting for inflation. As of writing, the average inflation rate within the United States sits at 3.22%. What exactly does this mean? Well, take that quarter you have been saving and multiply it by 3.22%. Then, take that answer and subtract it from your original quarter. When all is said and done, you end up with a value of 24.19 cents. Thus once inflation kicks in, you can expect to lose 4/5th of a penny.

A penny? Big deal you might say. Well, imagine if that initial quarter was a larger sum of money in the range of thousands of dollars. Suddenly, you have begun to bleed money. Additionally, it is important to note that inflation is not a one-time calculation, rather it’s a yearly expense.

So, about every 20 years, one can expect inflation to double costs and in turn lower purchasing power if inflation isn’t considered when factoring expenses.

The need to account for inflation requires the need for a better method of storing money than in a piggy bank. Now you might suggest putting money in an accredit saving account. However, I would argue the use of a savings account is no different than storing your money under a bed. It is true that those who store their money in accredited banks will get a small percentage of their saving back in the form of an annual percentage yield. However, the average APY (0.09%) one can expect to receive still remains grossly below the inflation rate. Thus, by putting your savings into a bank, you are lighting a fire beneath your money and allowing it to slowly burn away.

So if we can’t trust savings accounts to keep our money safe, is there an actual way to protect your lump sum of money? Of course, there is! But it’s not with banks. If you know me, you know that I will always encourage the use of the stock market when looking to invest your hard-earned money. But Luke, the stocks are volatile you say. In response, I would say it is only as volatile as the amount of risk you are willing to account for. If your goal is to just hold onto your money and not lose your saving to inflation, then play the market safely. All you need is a market return of 3.22% annually. 3.22% is far below the average yearly return for most investors. Take the S&P 500, historically (historical numbers can be traced well over 90 years of market trading) this index fund has had a predictable return rate of around 9%. So, a return rate of 3.22% is quite achievable.

If you are still concerned about playing the market, I have a second solution for you. Rather than investing in the stock market, take your money and store it in treasury bonds. Treasury bonds are what savings accounts should be. With an average APY of around 3%, treasury bonds near the rate of inflation. Thus, the money you put into bonds should have near the same purchasing power 20 years later on. Additionally, treasury bonds are known to be low-risk investments because they are backed by the federal government. So, unless the federal government collapsed within the next year, your money should be safe.

To sum things up, teaching your children the importance of properly saving, stands to benefit their future in the long run. However, you must know how savings works before you attempt to teach others. So throw away that plastic bank and bestow your child with a bond receipt. It might not be as flashy, but they will thank you in the future.