Most of us grew up believing that putting money in the bank and saving was the smart thing to do.
If our money is secure in the bank, surely we’re on the right path to building wealth. The problem with that theory is the concept of ‘idle Money’.
Idle money refers to cash or liquid assets not actively invested or used in any productive capacity.
When money is left idle, especially in low-interest bank accounts, it tends to lose value over time due to inflation.
For example, if inflation is 3% per year, the same amount of money will buy 3% fewer goods and services. Consequently, the longer money sits idle without earning returns, the more it loses its value in real terms.
Until recent years, most people hadn’t given inflation a second thought. Australia’s annualised inflation rate was less than 2% between 2015 and 2020. But then COVID hit, and with Government funds flowing into the economy, the inflation rate surged, hitting 6.59% in 2022.
Suddenly, millions of Australians started to appreciate the true cost of inflation. Not only were goods much more expensive but the money people had to pay for things was quickly losing value.
Further, inflation has had a nasty knock-on effect for those with money in the bank as it also reduces the real interest rate on savings or fixed deposits. That’s because if the inflation rate is higher than the interest rate offered by a bank, the real return becomes negative. For instance, if a savings account offers 1% interest but inflation is 4%, the real return on that savings is actually -3%. Thus, even though the account holder may see their balance increase nominally, the purchasing power of that balance decreases over time, making idle money a poor hedge against inflation.
What to do about idle money
To counteract the effects of inflation on idle money, individuals can seek investment opportunities that offer higher returns, such as real estate. These assets tend to provide returns that either match or outpace inflation, preserving or increasing the value of money. However, doing nothing and leaving money idle, especially in low-interest accounts, gradually erases wealth over time.
Concerned about your savings going backwards? Talk with us today about how investing in a house and land package is a wise long-term alternative that counters the inflationary risks associated with idle money.