How money in your Savings Account loses purchasing power

Since the beginning of time, our ancestors have told us to save money. In their defence, they're simply doing what they think is best; storing money without losing money. While money in a savings account isn't lost, what is lost, is the purchasing power of that money. I'll break this down below.

Firstly, what is inflation?

Wikipedia explains inflation best: In economics, inflation is a general rise in the price level of an economy over a period of time. When the general price level rises, each unit of currency (dollars, pounds, etc) buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money.

How Savings Lose Purchasing Power

In the U.K, the average inflation rate is around 2% per year, and banks offer a 0.05% interest on savings accounts. Now that you know the basic inflation rate + the interest on savings per year, let's take a look at this example showing how savings accounts barely increases with inflation:

You have £1000 in your savings account and you want to buy a bike that costs £1,000 in 2020.

You decide to wait three years to get the bike, hoping the interest from your savings account will help you out.

0.05% x 3 (3 years) = 0.15%. So 0.15% in interest on your £1,000 = £1.50. In three years, your bank has paid you £1.50 in interest.

Since inflation increases at roughly 2% per year and three years have passed, the bike has now increased by a total of 6% (£60), meaning the bike is now worth £1,060.

Now you see how money in your savings account loses purchasing power as the economy grows. Although we aren't losing money in our accounts, we're gradually losing the ability to keep up with the growth of our economy.

And this, ladies and gentlemen, is how your savings accounts are losing purchasing power.