Real vs. Nominal Interest Rates
Let’s say one year ago you deposited $10,000 in Marcus account by Goldman Sachs which pays .8% interest and today you are about to collect $10,080 in cash. What is the real return on your investment? That depends on what money can buy these days relative to what you could buy a year ago.

How do you measure that?

The consumer price index (CPI) measures purchasing power by averaging the prices of goods and services that an average urban family of four buys for day-to-day living.

In the last year the CPI has risen by about 1%.

The nominal interest rate is the growth of your money, the real interest rate is the growth of your purchasing power, which in this case would actually have been negative because .8% - 1% = -.2%. You would have lost $20 in purchasing power.

A CPI of 1% is quite low. I think with all the government stimulus the CPI will be higher than 1% in the next couple of years.

This is why I think people are going to be pushed up the risk curve; normal savings accounts are going to leave people with less purchasing power than when they put their money in. They’re going to be more willing to dive into stocks because losing purchasing power isn’t acceptable.

For you personally, are you comfortable with losing a bit of purchasing power with the money you have in savings?
North Star Capital's avatar
I'm fine with losing a bit of purchasing power because I only keep 6-12 months of expenses in my savings account as an emergency fund. This loss in purchasing power is offset by any fixed loans you have since you are paying back lenders with money that is worth less than it was when it was originally borrowed. So for me, I don't think it makes sense to go up the risk curve to chase yield.
Nathan Worden's avatar
This is a good approach. 6-12 months of expenses in a savings account is money that I'd also rather have .2% less of rather than the possibility of 10% less if it were in stocks.

And I like the way you're thinking about loans. That debt is also being decreased by interest as well. Mortgages / student loans are so common, so that is one bright side of inflation you could say.

Thanks for your thoughts
Joshua's avatar
I think it'll be super interesting to watch over the next few months what happens to the market, and the actual value of liquid cash. The market's going on a crazy run, the election likely will cause bumps and hurdles, and the CPI likely will change- I haven't looked into how the pandemic has affected the CPI but I'd be seriously interested to see the macro effects a few years from now.
Joshua's avatar
then again, you could probably apply this thinking to every financial market/concept in general :shrug: