Why Inflation Matters When Choosing A Savings Account

Three Reserve Bank of Australia (RBA) rate cuts in 2019 have taken the cash rate to a record low of 0.75%. In response, big banks are slashing their savings rates and their home loan rates. Here’s what that means for your saving account.

National Australia Bank (NAB) just dropped its savings rate by 0.15%, down to a maximum introductory rate of 1.55 per cent for four months, while ANZ is offering a base savings rate of just 0.05%.

Neobanks, however, are taking a different approach. Their digital-only offering reduces overhead costs, which means they can afford to offer some of the highest savings rates on the market, overshadowing the big four’s introductory base rates by as much as 2.20%.

Data accurate as at 23.01.2020 according to the RateCity database.

What to look for when choosing a savings account

If you’re looking for a savings account where you can store money for emergencies, and that will also earn interest, there are a few things you should consider:

• No monthly fees: Opening a savings account with a $10 monthly account fee would cost you $120 per year, so you may want to look for an account with no fees.
• No minimum deposit amount: Some savings accounts only pay interest if you deposit a minimum amount each month, which could mean missing out on interest altogether.
• Easy access: If you need to use your savings in an emergency, choose an account with mobile and online banking, so you can be sure to access your money when you need it.
• A rate above inflation: Getting a higher rate on your savings account than the inflation rate can be the difference between ‘parking’ your money, and earning real interest.





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Why inflation matters when choosing a savings account

Something that you should consider when choosing a savings account is whether the interest rate you are being offered is above the current rate of inflation.

The inflation rate, currently at 1.7%, is a figure used by the Reserve Bank of Australia (RBA) to show the rate at which the value of goods and services increase over a certain period of time. The average annual inflation rate from September 2018 to Sept 2019 of 1.7% will be reviewed on the 29th of January 2020.

An easy way to understand the inflation rate is to think about what you used to be able to buy with $1 back in the day, compared to what you can buy now (basically nothing). Unless you studied economics, or frequently visit the RBA website, the inflation rate isn’t common knowledge.

Why it helps to keep your savings rate above the inflation rate can also be a little confusing, so here’s an example.

Let’s say you were to deposit $1000 into a savings account for one year. The savings account offers an intro rate of 1.65% p.a. for four months, then a base rate of 0.10% p.a. for the remaining eight months. If you deposit $1000, you could earn $6.16 in total interest over the course of one year, taking your savings to $1006.16.

If however, you made a deposit of $1000 in a savings account with a neobank offering 2.25% interest for the entire year, you could earn $22.50 over the 12 months, taking your total savings to $1022.50.

*This data does not factor in any additional deposits made into the savings account, and is based on simple interest calculations. Check with your lender directly as to whether they use compound interest or simple interest calculations when choosing your savings account.

Whilst it’s obvious that the higher interest rate means you can earn more money, the relationship to inflation is the tricky part.

To put it simply, if your savings rate is below the inflation rate, you are essentially ‘parking’ your money, rather than earning ‘real’ interest on it.

In one year, according to an annual inflation rate of 1.7%, you would need $1017 ($1000 x 1.7%) to buy goods and services worth $1000 at the time you made your deposit. If you want to save $1000 and opt for a rate under the inflation that earns you less than $17 interest in one year, your savings will be of less value when paying for goods and services than it was at the time you invested it.

However, if you opt for a savings rate that earns you more than $17 per year in interest when you deposit $1000, your savings will earn you ‘real interest,’ as well as accounting for the rising costs of products and services in the economy.