Inflation is the rate in which the price of goods and services are rising, which said a different way is the rate at which our money is losing value.

While inflation might not be obvious from one day to the next, when you look out over a few years the numbers start to look pretty scary.

Imagine you have $1,000 in a transaction account (earning no interest) and the rate of inflation is 3% per annum. In just 10 years, inflation would have reduced the value of your money by $260. That means, while you’ll still have that same $1,000 in your account, it will only have the purchasing power of $740 today.

That’s a huge loss in value for simply having your money sit in a transaction account.

Smart savers never let their money sit idle

Those that are savvy with money guard against this by never having any more money than is required sitting in a transaction or low-interest account. By regularly ‘sweeping’ money into a higher interest savings option they reduce the impact inflation has on their wealth while also helping remove the temptation to overspend.

But the really smart savers go one step further – setting up a reoccurring payment from their transaction account into their savings on pay day – minimising the time their money is not earning interest. This one act has been proven to be a saving superpower – with several studies showing that automating your saving this way and effectively removing your impulsive or forgetful self from the equation, hugely lifts your chances of reaching your financial goals.

But, sadly, even these clever hacks are unlikely to be enough to get ahead

The smartest savers of all know that their money is never going to earn an interest rate as high as the rate of inflation, once tax is deducted, if it sits in a bank account.

Below is a chart of the annual rate in which money that sits in the average on-call bank savings account in New Zealand loses its value. Of course, the numbers are much worse for money sitting in a transaction account earning no interest.

‍

‍

‍

So, what are people doing about this?

Sadly, not much, as evidenced by the $126 billion sitting in transaction accounts and the $112 billion sitting in bank savings accounts currently. But those that are trying to stop their wealth from being spat off the back to the inflation treadmill are mostly doing one or more of the following:

Term deposit laddering

Laddering is where you split your money across several term deposits with staggered maturity dates, instead of locking all your savings up for one single term. This approach gives you more regular access of your money than one term deposit does and allows you to achieve a higher interest rate on your money than what’s on offer from a bank savings account.

A downside being this strategy can be time consuming. The more laddered your term deposits the more flexibility you have, but you also have to rollover the deposits more often.

Meaning, to do it properly, you'll also need to keep a close eye on which bank is offering the best rates for various terms and move your money accordingly.

Also, Murphy’s Law may suggest just when you need access to your money, there could be a chance you're between maturities on your term deposits or the next maturity is not enough money for what you need to access.

Investing in Cash Funds

Low risk managed investment funds, often called Cash Funds, are another option that some savers go for when trying to earn a positive return in their money after tax and inflation.

One big benefit over term deposits is that these funds often allow you quick access to your money. They are also usually structured as a Portfolio Investment Entity (PIE). Which can be an easy way to lift your after-tax return as the tax you pay on the interest you earn is capped at 28%.

PIEs are clearly great for those who are in the 30% or higher income tax bracket – which according to Figure.NZ is over half the working population in New Zealand.

However, these funds also have a major drawback. Unlike bank savings accounts, they charge fixed, and often high, fees and deliver uncertain returns. Which is not ideal for most savers or risk averse investors who most demand a stable growing balance.

Digital Savings Accounts

Then there is the growing number of online accounts being offered by financial institutions or fintechs in New Zealand. Many of these accounts carry higher interest rates, offer greater flexibility, and include more innovative features when compared to traditional bank accounts.

Similar to laddering term deposits, one drawback is that many don’t provide the tax benefit of being a PIE. But because these are essentially bank accounts (provided by a partner bank) that sit behind the fintech's digital user-friendly 'shop front' - it is easy to see why these higher earning alternatives are growing in popularity.

It is worth keeping in mind, that the interest rate paid on these accounts is largely determined by the bank sitting behind the fintech. So, while most of the banks involved are currently offering their fintech partners, and therefore the fintech's customers, better interest rates than they offer their own customers (which itself deserves its own article) these rates might not always be this attractive.

But, for now, digital savings accounts are proving to be a positive step in the right direction.