When you keep a significant amount of cash in a checking account, you might think it’s safe, but in reality, your money could be slowly losing value. This isn’t about the risk of theft or volatility; it’s about the silent thief known as inflation.
Essentially, even though the dollar amount in your account stays the same, the amount of goods and services you can buy with that money decreases over time. To understand this fully, there are two types of returns to consider – nominal and real.
Nominal returns are the face value of your returns – the straightforward percentage increase or decrease in your money. Real returns, however, are what matter more because they take inflation into account, showing how much your purchasing power has actually changed.
For example, imagine a basket of groceries that cost $100 last year. Due to inflation, this year, the same groceries cost $130. If your money is just sitting in a checking account earning no interest, you can buy less with it this year compared to last. Thus, your purchasing power has decreased.
This negative effect also compounds over time. According to Visual Capitalist, $1 in 1913 had the same buying power as about $26 in 2020. With the inflation spikes of 2021 and 2022, that disparity has likely increased even more.