Whenever you save up a bit of money, you first need to find a place to put it. The easiest option is to just hold on to your money, keeping it at home or in your wallet (or purse). While this avoids the financial risks associated with investment, this method of storing your money won't earn you any extra income or interest. At first glance, this wouldn't seem to be a problem, but in reality the purchasing power of your money will actually deteriorate over time due to inflation.

Inflation describes a decrease in the value of money and the corresponding rise in the prices of goods and services. Imagine that you have $1 million saved up and you would like to see these savings grow. Supposing that the annual rate of inflation is 12% (which is quite typical), it follows that inflation is 1% per month. To maintain the purchasing power of your savings through the first month, you will need to increase your capital by $10,000 (1% of $1 million). If you choose to hold on to your money (in this example, let's just pretend you keep it under your matress, where it won't accrue any interest) the relative value will actually decrease! Just to keep your purchasing power (the amount of goods and services your money can buy) from dropping , your savings should increase by at least 1% per month.

The most common solution is to deposit money in the bank. The problem is that current bank interest rates barely cover the rate of inflation, if they do at all. With the current economic conditions, the most effective and reliable way to store your money is investment.

Read more...