How to really build a fortune
A German tradition
There is something just as German as bratwurst, sauerkraut and the autobahn (just to name a few clichés): it is the savings account (“sparbuch”). This form of putting money aside has a very long history reaching back to the early 19th century. Still today, basically every child receives a sparbuch from its parents or grand parents. Given the long history and the persistence of this act it can be considered a German tradition. But does the idea behind it really work? Welcome to Savings Account: a German Myth.
Needless to say, savings accounts are not only popular in Germany. So, this article is for everyone who has one or is thinking about setting one up for his or her kids.
The understandable and honorable idea behind a savings account is to save money and to build up a small fortune or at least a nice financial cushion over time. Essentially, we give our money to a bank and are happy to get some interest back in return. In the past, interest rates were as high as 8% whereas today they slumber at close to 0%.
But at least we are making some profit and increase our wealth bit by bit, right? Well, not really. Savings accounts are actually a major wrecker of purchsing power.
Inflation and purchasing power
There’s a nice little piece of history: one of the oldest German savings accounts that is still active today was opened in 1904. Back then, Mr Boettsch deposited 100 Reichsmark for hier little nephew. 115 years, 2 world wars, 2 currency reforms and several economic crises later these 100 Reichsmark had turned into about 390 EUR.
The immediate reaction is: awesome, the value has almost quadrupled! But what is the value of money? The number in front of the currency symbol? Or the goods and services that we can buy for that number of Euros, Dollars, Pounds etc?
Back in 1904, Mr Boettsch could have bought about 900 beers in a restaurant. His descendant today can buy about 100 beers for those 390 EUR. Hence, the effective value of that savings account has not quadrupled but was cut to 11%.
This brings us to the purchasing power of money which is directly influenced by the inflation. Since the inflation is almost always larger than zero, the money that we earn or have in our hands today will be worth less in the future. The graph below shows this evolution of inflation and purchasing power over the past 50 years in Germany (since 2002 this is equivalent to the EURO zone).
So, the 100 EUR I had hidden below my pillow in 1969 have lost about 75% of their value. Today, I can only buy 26.1% of the goods and services I could have bought back then. The main reason for this loss in purchasing power is the inflation which was as high as 7% in the 1970s and is now close to 2%.
Savings accounts and real interest rate
Coming back to the savings account. How would a 100 Euros deposit in 1969 have developed in terms of purchasing power? The graph below shows the real interest rate (the interest paid by the bank minus the inflation rate) and the purchasing power of those 100 Euros.
We can easily see that the real interest rate is often negative, meaning that our savings account is losing purchasing power. Over the course of the past 50 years the overall result is dissillusioning: we have lost 5% in purchsing power.
Long story short: a savings account will not build us any fortune. It does not even maintain the purchasing power of the money we put in. In effect, we lose money!
Just to illustrate the magnitude of this: people living in Germany have about 2500 Billion Euros stored in private savings accounts. At the current inflation rate of 1.8% this results in about 42.5 Billion Euros lost in purchasing power. Every year!
How to make real profit and build a fortune
One of the most reliable creators of material and monetary value is our economy. The worldwide economic growth has a proven track record of creating real value and is essentially represented by the development of our stock markets. Despite all financial bubbles, wars and economic downturns, the persistent growth of the economy is a fact. The graph below shows this economic development again for the past 50 years. I chose here the MSCI World Index which reflects the economic growth of 23 industrialized nations (North America, Western and Northern Europe, Israel, Australia, New Zealand).
This index has grown from 100 points in 1969 to almost 2300 points in 2019. In other words, had I invested 100 EUR into that index I’d have 2300 EUR today. And even when we substract the inflation rate we’d have a real, effective growth of purchasing power of 530%! I would have more than 6 times the purchasing power than back in 1969. Compare that to the progression of purchasing power in a savings account…
Naturally, every economy and stock market has its fluctuations. In the past decades, we saw two major financial crises: the “dotcom bubble” in the year 2000 and the subprime crisis in 2007. But everyone who thinks that banks are safer should remember that the subprime crisis was largely created by banks!
These economic downturns need to be factored in and in the long run, investing into the stock market will generate real profit. For me, stock market investments are a long term investment (like 30 years). I’m not interested in active trading. It takes too much time, requires a lot of information and statistics show that hardly anyone can beat the overall market in the long run.
Coming back to the financial crises: both the dotcom and the subprime crises were followed by strong economic growth. In both cases, the world index had reached the pre-crisis level after about 5 years. That’s why the long term investor should not be overly afraid of such economic downturns.
Passive and diversified investment into the stock market
Now, the big question is: how do I invest into the stock market with high diversification and minimal effort? After all, we do not want to spend a lot of time with our investments (at least I don’t) and high diversification lowers the risk.
The answer is: exchange traded funds (ETFs). These funds mimic a certain index (like the world index, the Nasdaq, the DAX, the EUROSTOXX, …) and can be bought in shares. You can find a wealth of information about ETFs at justetf.com.
All you need is a shares portfolio (“Depot”) at a bank that allows you to create a savings plan with ETFs. Many banks offer this for free (both the shares portfolio and the ETF savings plan): make sure you get a good deal or find the right bank to reduce your running costs. In Germany, there are quite a few good offers with a free portfolio, free savings plan and many ETFs that can be bought without any fee. Personally, I picked the Consorsbank which has a selection of 170 cost-free ETFs, has zero fees and offers a 20 EUR bonus for the first savings plan. You can follow this link to get this deal.
For the non-German readers: I’m sure you will have similar offers in your respective countries.
A big advantage of having an ETF savings plan with regular (e.g. monthly) deposits is that it will somewhat even out falling stock prices. During the time of falling stock prices, like in a financial crisis, your regular deposits will buy you more ETF shares. As a consequence, you will profit additionally when the stock market is recovering.
An example of a simple, diversified ETF savings plan
The MSCI World Index shown in the graphs above already offers a highly diversified investment. This index contains more than 1600 company shares from 23 industrialized countries. Over the past 30 years it had an average annual growth of 5.3% before inflation and 3.1% after inflation.
The MSCI World Emerging Markets Index is a good addition and tracks the economic growth of countries like China, India and Brasil. These markets often have a stronger growth than the industrialized countries but also higher volatility.
An “one in all” index is the MSCI All Country World Index (ACWI) which includes industrialized and emerging markets. This is a prime example of a highly diversified index that tracks more or less the entire world economy.
ETFs that mimic these indices are offered by iShares, comstage, Xtrackers or Lyxor and any bank will have these ETFs available for a savings plan. Again, make sure that you can get the ETF savings plan for free to maximize the gains.
The numbers are pretty clear: a conventional savings account will not give you a real appreciation of the money you put aside. The real profit is made by the banks and not by you. As history shows, the stock market is excellent for creating a real value increase and investing via ETFs is simple and cost-effective. A reasonable investment horizon should be 20 to 30 years in order to ride out future economic depressions.
As an addition to an ETF savings plan, diversified p2p investments like Bondora Go&Grow or Mintos Invest&Access can be interesting for a further diversification. Data from the last depression in 2008 shows that the p2p loan market is to some extent de-coupled from the stock market. Therefore, such investments can help to get through a crisis successfully.
They key message for building up your fortune is: start early, every penny counts. If you are still a student and can only put 50 Euros aside each 3 months: start doing that! Create a quarterly savings plan. It will pay off. And that’s not a German myth.