Your savings account is costing you money
For the past years, the interest rate set by the European Central Bank has been close to 0.0%. Banks use this number to determine the interest rate on your savings account. Mine, at BNP Paribas Fortis, is 0.11%. I suggest you check the interest rate of your own savings account.
Alright, it’s maybe not much, but you’re still earning a bit of money each year, right? On the contrary, you’re losing money, or rather purchasing power, because of this thing called inflation. Inflation causes prices to go up every year. The central bank attempts to keep the inflation rate at around 2%. They don't always succeed, and at times it's higher, other years a bit lower. But on average, you can expect the price of pretty much everything you buy today to be 2% higher than last year. Looking at it another way, your current savings are worth about 2% less than last year because of inflation. And because inflation has been higher than the interest rate, you’ve been losing money by keeping your savings on a savings account.
Passive investing to beat inflation
But what can I do, I hear you say? I know I could invest my savings, but I know nothing about financial stuff. I don’t know anything about the stock market. Nor do I have the time, or the interest, to follow my investments every day and sell before I lose all my money.
The answer has been around since the eighties but until recently, it has been largely left underappreciated. It’s called passive investing. It’s based on the observation that rather than hand-picking stocks and trying to buy and sell at the right time, it’s usually more profitable to invest in the stock market as a whole.
Think about it: when you’re picking stocks, you are looking for the best bargains, and choosing companies that are cheap now but that you predict will go up in value in the future. However, remember that you are competing with all the other investors in the world who are looking for the same bargains. Not just people like you, but mostly top analysts at big investments firms and banks, who are paid big salaries to spend the entire day researching industries and analysing quarterly reports, all while keeping an eye on the television’s screen that is showing CNBC for the latest news on the markets. How can you possibly compete with them? By the time your uncle tells you over Sunday lunch about this great stock he heard about, these people would have spotted the opportunity, bought thousands of shares for their firm and caused the stock’s price to increase drastically. So you end up missing out on that hot bargain.
So, how does passive investing work? It’s simple: you invest in index funds. An index is like a bag of stocks where the rules are very clear on which stocks are included and how much you get of each company. The most famous index is the S&P 500, which has the 500 biggest American companies, weighted by market capitalization. The MSCI World index is another common one. It consists of over 1,600 companies across the developed markets (US, Europe, Australia, Japan,…).
That’s all very interesting, but how does the return of an index fund compare to a savings account? Let’s look at the historical performance for the MSCI World index since 1979:
A €10,000 investment in 1979 would have resulted in €960,000 today. The number that summarizes this entire chart is the annual average return rate: 11.1%. As you have probably noticed, this number is significantly higher than the return that you are earning from a savings account.
Passive investing vs a savings account
The difference is really put into perspective when you look at the returns over several decades. Imagine Lucas and Emma, two people who are both about to retire at 65 years old. They started working at the same age, 40 years ago when they were 25. For all these years, they’ve consistently been saving 100€ every month. There’s one difference: Lucas didn’t know anything about investing so he put all of his hard earned savings into a savings account with a steady annual return of 1%. On the other hand, Emma was fortunate enough to have learned about passive investing when she was a student. Because of that, she has been putting her monthly savings into an index fund tracking the MSCI World index.
You can probably predict that Emma’s nest egg for retirement will be bigger than Lucas’. But let’s just see how much.
By age 65, both Lucas and Emma would have put aside the same amount of €48,000. With his steady 1% returns on interest, Lucas will have grown this to €58,989 (blue line). In the meantime, Emma’s has grown to a staggering €335,185 (red line)! This is over 5 times more than what Lucas has, and none of this required time nor financial expertise from Emma. All she had to do was to deposit her savings into an index fund rather than the savings account at her bank. This chart is all you need to understand why you should passively invest your savings instead of keeping it all on a savings account.
The difficulties of investing on your own
There is a learning curve if you want to manage your own investments in index funds. You have to choose the right mix of indexes tailored to your objectives and appetite for risk, you need to understand how taxes work, you have to choose a broker... In investing, mistakes can be costly so these topics are important to master.
We understand though that not everyone has the interest, time or motivation to teach themselves these things. So at Curvo, all these complexities are taken care of for you. Find out how it works.