WHY YOU DONT NEED A SAVINGS ACCOUNT

Earlier this week, I talked to a pal of mine called Prof for purposes of this blog about an issue that’s been vexing me.
Savings Accounts are they relevant today?(pole it sounds like those Primary school debate questions: "Are boys better than girls?")

Here is what he had to say.

ME: Do you need a Savings Account?

Prof: Yes and no. Remember there are two types of savings:
TYPE1, you need savings in case you loose your job or have some other disaster you can use the money.
Type 2, you need savings as capital for investments, build a house, buy a car, retire, marry a third wife, become an M.P.............etc. (or any other dream you have)
Now, I assume that you have some money sitting somewhere in a bank account (type 1 of savings). I will address type 2.

ME: So savings are: (1) Transactional purposes
(2) Investment
Prof: Ahhh... (tapping his forehead)… you are getting the drift.

ME: For long-term savings beyond a period of 1 year, is a bank account good?

Prof: You mean a savings account or fixed deposit at a bank like NIC, KCB, Barclays, Equity...etc

ME: Right

Prof: No, because they give you a stupid rate of interest and your money gets a better return elsewhere.

ME: But prof, I thought an interest rate was good, any rate.

Prof: Ha.ha.aha…(coughing almost choking on his Tusker). Your ignorance amuses me. You have never had of inflation?

ME: Well....

Prof:Inflation simply refers to the loss of value of money over time. For instance a loaf of bread cost sh.15/= 10 years ago but now costs sh.25/=.

For more about inflation look at this sites:
-http://www.investopedia.com/ask/answers/156.asp
-http://www.investopedia.com/university/inflation

ME: So what has Supaloaf got to do with my bank account?

Prof: As long as you have your money in a bank account that is losing value every year, by the time you want to use your money it will no longer be of any value.

ME: I am lost prof.

Prof: Let me explain using the bread example. Assume in 1996 you had Sh.1500, which was enough to buy 100 loaves. (1500/15=100).
You kept the money in an account that earned no interest and had no bank charges (for illustrative purposes). Today in 2006 you have sh.1500 and the price of bread is sh. 25. Your money can only buy 60 loaves (1500/25=60). Unlike 100 loaves 10 years ago, a loss of 40 loaves in 10 years.

ME: I see............

Prof: Lets say you earn 5% interest on your savings Account. But annual inflation is at 14% today. You money is losing value at the rate of 9%. That is (Inflation rate-Savings rate) i.e. (14%-5%=9%)

ME: So whats the way out?

Prof: You need to invest in areas where your rate of return is higher than inflation. That’s why the NSE is rising because inflation in Kenya is at 14% but Treasury Bill rates are less than 8%.

ME: So NSE has a bubble?

Prof: That's a question for another day. Let me put it like this, If the inflation rate remained constant at 14% but the Treasury Bill rate went to 25%, I don't think the NSE index would be at 4000 and above.

ME: So inflation is part of what is driving the NSE?

Prof: Yes, but we will talk about that later. Savings Accounts right.... that’s what we were on?

Me: Yes, I wanted to know what options to take on saving.

Prof: For, long term saving (over and for 1 year) I would advise two options:
1-Money market funds. Like the ones offered by Old Mutual, African Alliance and British American. They mimic a savings Account and have a high return around 8% and you can access your money relatively fast. Plus you don't loose your PRINCIPAL amount.

2.SACCOs- Some SACCO’s offer savings products that give you a rate of 10% per annum. The only downside is that you can't access your funds for at least 6 months.

ME: So I buy unit trusts and cozy up to my SACCO?

Prof: Right, just don't buy any unit with the words BALANCED and Equity in them because this are linked with stocks. Their values will fluctuate with the stock market. When the stock market goes up- so will they. When it goes down so will the equity linked units.

Me: What about...?

Prof: Almost forgot. Before you start investing have some Savings cash float in a Real Savings Account. (Just in case you need cash in a hurry) So that you don't liquidate your long-term savings or investments in a hurry.

Me: What?

Prof: Keep looking for any investment vehicle that doesn't jeorpadise your PRINCIPAL and can give you a higher return than inflation.