We all know (or should know) that having an emergency fund is a good thing, and I think most people would agree that the best place to keep your emergency fund is in a high yield savings account or a short-term CD. However, I try not to keep a lot of money in my emergency fund — or any savings account for that matter. Why? Negative real return. Basically, inflation takes more away than you gain from the low interest rate offered by these accounts, resulting in the reduction of value of your savings.
I think the best way to demonstrate this concept is with a real life example:
In this case, if you started an emergency fund by putting $10,000 in your Everbank account in April 2009, you would have $10,151 in your account after a year. Unfortunately, things that used to cost $10,000 in April 2009, would cost you $10,220 in April 2010. In other words, your money worth less than it used to a year ago — 0.69% less to be exact — and not to mention that you have to pay taxes on the $151 “gain”.
If saving money in a high yield savings account is a losing proposition, what are some good ways to deal with this? Here are a couple of ideas to make your money work harder:
These are just a few ideas I came up with while putting this article together. Please chime in with other suggestions. I’m interested to know how other people deal with negative real return in practice.