The dangers of holding Cash

Bank accounts are a necessity in this day and age. But just like that deadbeat ex you might of had once, sticking to what you know and is familiar could be hurting you financially!

The best bank account

The best online bank accounts are those, which provide you no fees and give you a decent savings interest rate on your balance. We all know that keeping too much cash isn’t a great idea due to inflation meaning that your purchasing power is actually eroding every year.

So having a decent savings interest rate paid on your cash at around this rate lets you preserve your some of your purchasing power (but we all know in the long run that savers are losers, and a smart investor like Warren Buffet will put their money to work in a low fee stock market index ETF).

Before I get into how to get the best bank account, I want to rehash a quick and dirty discussion on modern finance to keep everything in perspective and explain why I allocate assets the way I do…

Interest rates

Inflation is often called the ‘hidden tax’ on the working class. This is a very real tax that hurts savers. The Reserve Bank has some levers it can pull to keep the economy ticking along, and one of these levers is the overnight cash rate – essentially what lenders (the banks) have to pay each other for overnight outstanding settlements. This cash rate trickles down with second and third order effects through businesses and eventually hits you the consumer, as inflation or the rate of inflation (the rate that stuff gets more expensive).

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Interest rates are linked to inflation and are a monetary policy tool from the Reserve Bank

The fact is that in today’s financial climate with historically incredibly low interest rates, cash is trash. Savers are most likely going backwards in terms of purchasing power, since the rate of inflation is higher than the interest you’ll receive on savings accounts or term deposits. Cash is dumb.

Savers are dumb

So lets run through the math – lets say you’ve got $100K in your savings account, earning paltry 2% interest from a bank. At the end of the year, you’ve made a cool $2000 in passive income – great – or is it?

You know your going to lose some of this to the hidden secret power of inflation. But if you think that’s it, sorry there is more. You’ll also be hit with a double whammy which is the income tax that you’ll pay on the interest you earn from your savings! All the while the purchasing power of your cash is eroding – each year you can buy less and less with it. Sucked in, Savers! (Or so the treasurer would say…)

If you’re an average worker, your marginal tax rate is probably sitting somewhere around 30%, that is, you’ll be charged tax on this interest as income at a rate of 30c in the dollar. The government does not factor in the inflation and loss of purchasing power; they just want the most taxation income. So the balance looks something like;

  • $100,000 purchasing power start of year
  • $2,000 interest
  • -$600 income tax payable on your tax return
  • -$3000 maximum theoretical inflation

Total purchasing power after 12 months: $99,000, PLUS a $600 tax bill leaves you with $98,400.

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So by sticking your money in the bank, you just made a negative return! A grant total of -1.6%. Clearly not a great idea for anyone in pursuit of Financial Independence. Even if you could secure a great interest rate of 3% (equal to inflation), due to the effect of income taxation you still end up losing out of almost $1000, which is a 1% negative return on real purchasing power! They don’t teach this at schools!

On the plus side, most governments have a savings deposit guarantee so even though you are losing money, you will know just how much money you will lose every year. In Australia, the federal government insures individuals for up to $250K worth of their savings – if the bank goes bust, you will still get back your savings (but only up to $250K). This isn’t really an issue, because if you wanted to spread out more cash investments I think you could just use multiple banks, each being federally insured for $250K, but for the reasons listed you’d end up going backwards over time.

Monetary policy is orchestrated to penalise savers; because savers are not great for an economy – stuffing your cash in your knickers draw or under the mattress doesn’t really help anyone (especially yourself or your FI date!).

Clearly then those that are in the wealth accumulation stage prior to FI should try and minimise the cash drag on their portfolio. Excluding of course, a reasonably sized emergency fund. What is reasonable for one may not be so for another, this would all depend on your cost of living, family size, and the stability and inherent risk in your job (for example as a professional pilot with no kids yet, I can afford to keep a much smaller emergency fund and direct all of the rest into stock market ETFs).

Spenders are drones

Spenders and consumers are good for the economy, as they stimulate business and production and ‘keep the machine oiled’. This makes profits for business, which employ people. The spenders are then locked into being workers too, in order to continue to pay for all the stuff they are buying – meaning the nation has a strong workforce.

If you spend most of your paycheck, you might end up with this noose around your neck for your whole life

The recipe for real long term wealth generation is to earn more income, spend less of it and invest the difference. Over a long time period, this habit can easily make you a Millionaire (if you don’t believe me, have a read of the book ‘The Millionaire next door’!). For example, some of the countries with the lowest percentages of consumer spending (and the highest level of household saving and investing) are:

  • Luxembourg
  • Switzerland
  • Sweden
  • Germany and;
  • The Netherlands.

These also happen to be some of the countries with the highest incomes, too (interesting correlation, or is it?).The top 10 countries by consumer expenditure in 2016 were ranked as

  • United States of America
  • China
  • Japan
  • Germany
  • India
  • UK
  • France
  • Brazil
  • Italy, and
  • Canada.

This effect is magnified by the tool of ‘credit’ (a very useful but also dangerous concept invented by bankers). Some foolish people can end up in consumer debt or bad debt (that is, any debt for a liability rather than an asset) which can ruin their life, or at best seriously delay them from reaching FI.

Investors are smart

If spenders are good for the economy, then investors are even better! when Investors behave properly, they are rewarded handsomely as such! Of course people are irrational and investors are people, therefore a lot of investors are irrational (and by the way, a smart investor like me can take advantage of this irrational behaviour by just continuing to buy stock market index ETF funds over time irregardless of price).

When an investor starts investing their money into the right assets, they make the world a better place. Rather than hoarding their wealth like savers might by keeping money under their mattress (or the modern equivalent in an online savings account), or by buying a lump of metal (like gold, which produces literally NOTHING!), a smart investor will be investing their money in productive businesses. They are allowing their capital to be used for innovation; human ingenuity and development to

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Bank accounts

OK back to bank accounts and cash. So even though you don’t want to have your capital sitting around as cash, you need a good savings buffer. I like to keep two years worth of living expenses, which is about 30K. This is because I am pretty frugal and a very aggressive investor due to my investment timeframe; FIRE in 2023 and then 70 years of living it up! I have the rest of my money invested in ETFs, and will shortly be settling on my first investment property (~2K down contract with 3.5% interest over a 30 year loan on a cash flow positive rental with good capital growth prospects).

Some people will need more cash than others due to having a larger family, owning their PPOR or by having a riskier or unsteady job. For home owners or property investors, as explainer earlier a convenient way to maximise your cash return on your emergency savings is to use an offset account on your mortgage: you still have access to the cash, but it is working much harder for you than it would in an online savings account. You probably still want a small emergency savings or ’Mojo’ account somewhere completely different just in case, and for quick access.

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You should always keep a reasonable emergency savings or rainy day fund

The best bank accounts

The best way to get a good account with no fee’s and a decent interest rate is to go with a discount online bank. By saving on overheads like offices and front of house customer service representatives, they can pass the savings on to you by charging little to no fee’s and giving you a decent rate.

In Australia, at the time of writing I think the following four are my top picks for an online bank; however the rates are changing frequently due to the RBA changing the cash rate. These banks provide good website and app interfaces, as well as a highly competitive rate amongst the other banks.

Captain FI, CaptainFI, FI,ING

      ING:

Captain FI, CaptainFI, FI, ME

MeBank:

Captain FI, CaptainFI, FI, Ubank, U bank

Ubank :

Captain FI, CaptainFI, FI, RAMS

Rams:

There are many other banks out there that offer a very short period of higher interest, but these quickly fizzle out and leave you with a paltry 1% or so. That is only going to assure you lose purchasing power through inflation and taxation! There are options for term deposits too, but I would steer clear of these as you don’t earn much more than these online savers, and your money is locked up and can’t be used in an emergency (so why the f wouldn’t you just buy ETFs with it instead). These banks will give you these rates on a condition though; they want you to either use their transaction accounts, have your salary deposited into them or make a regular monthly contribution to your savings accounts.

This is actually not a problem, because their transaction accounts are the best ones I have found – ING charges no fees ever, and provides a great exchange rate for overseas purchases. Ubank wants at least $200 a month deposit to qualify for the higher interest rate, however Rams is the only one which penalises you for withdrawing from your savings account.

A neat little ‘hack’ if you don’t have a large enough income (I think INGs threshold is only $1000 a month though) or if you can’t save as much as the threshold saving contribution you can just juggle money between accounts on automated online transfers to get the higher interest. It literally takes 30 seconds to set up and is incredibly satisfying.

If you want to start up an ING account (the best online bank account in Australia) and want $25 for free, use the following ING promocode…

FKQ674

Other ways to maximise interest

If your still looking for ways to maximise your earnings, have a look at starting a fee free credit card. Making purchases on credit and paying them off on time means you’ll never pay interest on the credit, and your cash can be stashed away earning interest. Even better it could be offsetting your mortgage or invested in ETFs. You can also get some ripper sign up bonuses like points, frequent flier miles or cashback and you don’t even have to keep the card – this is called credit card spoofing or hacking and it’s a fun hobby of mine.

CaptainFI

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