Why having money in the bank can make you poorer.

In a previous blog I said I would talk about things which are incredibly obvious to some, but not however to everyone. The name of that blog was in fact “Stating the damn obvious”, click here to read it. Today what I want to speak about is why having money in the bank can make you poorer.

Money is not wealth.

Money, money, money, the name of a famous Abba song.

Image source.

“Money, money, money, in a rich man’s world”, as the famous Abba song goes.

Money is not wealth but merely a means of accessing wealth. Money in of itself has no inherent value and is merely a means to an end, the end being acquiring things, services and so forth. It is often just a piece of paper. Money is also a means of measuring wealth. When someone has a certain amount of money we can say that he has the ability or potential to do X, Y and Z with it. If however someone has a billion dollars but lives the life of a pauper and lives in a shoebox, he has the ability and the potential to buy a huge mansion, but he does not do so. He is “wealthy” in that he has money, he is not wealthy in that he is not using or enjoying things which he could acquire with that money, namely in this case a beautiful house.

A miser holding on to his money very possessively.

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A beautiful house in California.

Image source.

Money depreciates

As time passes, the value of money goes down and down. What that means is 10 years ago $10 (even though I am British I am using dollars as it is still the world’s international currency) could buy you a certain amount of things. Maybe a hamburger, a bottle of milk and so forth.

10 years later you can’t buy as much as you could before, with that same $10. The $10 now has the same “purchasing power” (things you can buy with it) as $5 had 10 years ago.

In larger terms. If you became a millionaire today and bought what you wished to and then left the remaining cash in the bank, you would over time become poorer. Let us say you left half a million dollars i.e. $500,000 in the bank after spending the first half a million. You would of course gain interest on that money, but still 5 or 10 years later in real terms that $500,000 has the same value that $300,000 does now (depending on inflation).

So do the super-rich tend to leave lots of money in bank accounts. Yes, some do and some don’t. Some do so that they have cash, capital, whatever you want to call it which they can withdraw and use when they want to buy something or invest in something. Others however protect themselves from “money depreciation” by buying valuable things such as houses, expensive cars, jewellery, paintings. All of these things are assets which unlike money go up in value.

Sothebys, where paintings are sold for millions in auctions.

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Money goes down in value, Assets go up.

Also the money which you make from renting a house or flat that you’ve bought, which we call “rental income” is usually far more than money you would get from interest on your bank account. Also if you spent money on buying the house you can sell the house for a higher price later on and make a profit, unlike your bank account money which is static and goes down in value. Your credit rating would also be better as you have a house.

So do not hoarde money excessively as it goes down in value, but invest it where it will grow and make you more money.

So imagine there are two brothers, Peter and Simon. Peter has $1 million and spends half, and saves half of it in the bank and leaves it there.  Simon on the other hand spends half but saves a quarter in the bank and invests the other quarter in property, paintings, and jewellery, and sells them all all of 10 years later.  Then 10 years later Peter would still have $500,000 (plus interest), Simon however would have $250,000 (plus interest) and possibly $375,000 if all the property, paintings and jewellery went up by 50% over 10 years. If however he bought a much coveted masterpiece of art, he could possibly sell it for millions.

Money doesn’t grow on trees, but it does grow if you invest it in assets!

Money doesn't grow on trees, but it can grow with assets and investments. You can "lose money" if you leave it in the bank as the value decreases, thus making you poorer in real terms.

 Image source.

This is as I said in the beginning very, very simple and basic information for some. It isn’t for others however and hopefully they will find this useful. Having money in the bank for a long long time can make you poorer. Using it to make more money by buying assets will make you richer.

 

- Jahan Choudhry.

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