SmartyPig, the Stock Market, and Savings Options

I got back from the beach to find a notification that SmartyPig has reduced its APR to 1.10%, effective June 15th.  The Bureau of Labor Statistics puts the un-adjusted 12 month inflation rate at 3.2%.  That means that I am losing purchasing power by keeping my money in a SmartyPig account.

Here's how it works.  If the savings and inflation rates stay constant for the next year, if I put $100 in a SmartyPig account on June 15, 2011, the account will be worth $101.10 on June 15, 2012.  However, inflation will have eroded the value of $101.10 to the equivalent of $97.97.  To add insult to injury, I will also have to pay income tax on the "gain" from the interest.  Assuming a marginal tax rate of 15%, that is $0.15 in federal income tax, yielding purchasing power in June 2012 equivalent to $97.80 in June 2011 dollars.  Unless inflation falls or SmartyPig's interest rate rises, I am guaranteed to lose purchasing power over time by saving at SmartyPig.











So what is a saver to do?  There are no safe investments paying 3.2%.  1.10% is high for a savings account (Although I do get 1.25% at Discover because I have a credit card with them as well).  BankRate's highest 1 year bank CD is 1.4%.  One year treasuries are .18 and ten year treasuries are 2.28 today, according to the Department of the Treasury.  People are piling into corporate debt, but highly-rated corporate debt is barely beating inflation; you're not going to fund your retirement on 3.734% interest rates (the yield on a 10 year Google bond issued May 16th).  For instance, I recall that the annual rate of return in the retirement calculator Dave Ramesy uses in Total Money Makeover assumes an 8% average annual rate of return.  (I read the 2003 edition, the 2009 edition may have updated this)

Enter the Stock Market.  As of yesterday, the Dow Jones Industrial Average ("DJIA") gained 21.62% over the last year, closing at 12151 (per Morningstar).   Those are some impressive gains.  Also, unlike interest, which is taxed as income, long-term capital gains rates are 0-15%.  (If your marginal tax rate is 15%, your long-term capital gains rate is 0).  Next to the anemic yields of traditional save investments, the stock market is looking good, if it can continue the historical trends of the past couple of years.

But can it?  At it's height, on October 9, 2007, the DJIA closed at 14164.  As of today we're at 85.8% of the highest market in history.  And, just in case you didn't notice, the unemployment rate edged up to 9.1%.  Half the PF blogs I read right now seem to focus on either dealing with current unemployment or planning for future unemployment.  The housing market is in the toilet and expected to stay there.  Looking around, do you feel 85.8% as prosperous as you did on 2007?  If the DJIA rises another 21.62% in the next year, it will be at 14778 next June.  Does this seem likely to you?

For those of us who want to save money, it's a real catch-22.  Thanks to the Federal Reserve's decision to keep interest rates low, there is no such thing as a safe investment for our money.  We are forced to either lose purchasing power or move into moderately risky investments like the US stock market.  I think the current rise in stock prices signals not particular strength in the market, but the lack of any place else for money to go.

So what do I do now?  I keep my funds that I expect to use within the next six months close to hand in a savings account at Discover (because money is much easier to transfer in and out, and the APR is better at 1.25%).  The rest of my money is in various foreign and domestic equities and indexes.  But I am very tempted to lock in my gains now and wait for a more appetizing place to put my money to materialize.  Is anyone else feeling this pinch?  What are you doing with your savings?