It seems to me that one of the greatest disappointments we have in life is the realization that some basic principle or concept that we figured was a constant, something we could rely on as dependable, becomes a delusion, a mere fantasy. This is what has happened with a basic concept folks of my generation and that of our children grew up with in understanding personal finance. What we figured was a fundamental doctrine has now proven to be incorrect today.

I am referring to the belief that folks should save money, that is, regularly put some portion of our income aside into a savings account in a bank or credit union. (Last time I described how a savings account as essentially an “open-end, on- demand” loan to the bank meaning deposits and withdrawals may be made at any time. The fundamental principle is that money in a savings account is actually a loan by the depositor to the bank – and which then becomes part of the bank’s assets.)

Anyway, the idea was that money in a savings account would not be used for regular expenses such as groceries, shelter, and such, but would left to accumulate for future use. The amount would grow both by regular deposits and by interest which would be “compounded”, that is, paid not only on the principal, but on the interest already paid. The belief was that this process would result in a tidy “nest egg” over the years – a pile of money that would not only increase our net worth but would be available for some special purpose or unforeseen expense.

Well, this personal finance theory is no longer valid. Oh, sure, we still regularly put some of our income into a savings account, but only these deposits increase the value of that account. The reason is that the interest on savings accounts has become so puny. Our savings account pays .01 percent interest. To put this into perspective, if we keep $1000 in that account for a year, we earn – now get this – $1 ($1000 x .0001 = $1.00) – not enough to pay for a cup of coffee. And don’t forget about inflation – the buying power of money kept in a savings account actually decreases because of inflation.

So what does a bank do with customers’ deposits? Uses them as assets to lend money to other folks, that’s what. A friend of ours recently needed to replace the furnace and didn’t find enough change in the couch cushions to pay for it. The solution was to get a bank loan with an interest rate of 5.9 percent to cover the expenses. At that rate a standard amortization schedule shows the bank will earn a little more than $32 over a year for a $1000 loan. Simply put, the bank uses a depositor’s $1000 “loan” – for which it pays $1 – and uses it to make about $32. Multiply that by the many loans a bank makes and that’s how banks prosper.

Another service banks (and credit unions) offer is what is commonly known as Certificates of Deposit (CD’s) which is another way for a customer to lend money to a bank. A CD differs from a regular savings or checking account in that the customer deposits, that is, effectively lends, money to a bank or credit union at a fixed rate of interest for a fixed period of time with loss of interest for early withdrawal. Yields vary according to the length of time with higher yields for CD’s having a longer duration. Current effective annual returns range from a low of 0.1 percent a for a six month CD to as high as a little over 2 percent for one lasting five years. A bit better than a savings account but gotta remember the customer’s money, that is, the loan, is tied up for the duration of the CD and the buying power of that money decreases by the rate of inflation.

Some banks have reportedly introduced a new type of CD. The customer still “buys” a CD for a fixed duration but instead of a fixed yield, the yield is based on the market value of a bundle of stocks. If the stocks go up, the CD gains value, if the stocks go down, the CD loses value. Furthermore, increases are capped at plus 5 percent while the “floor” of decreases is minus 15 percent. Kind of a “heads I win and tails you lose” proposition for the unwary depositor, huh?

Among other “services” offered by banks and credit unions to entice customers to place money with them are ”money market”, “personal capital”, or some such funds which appear to have returns a bit better than savings accounts and less than CDs’. I don’t have a clue how these work, but one thing for sure – they are another way for a depositor to lend money to a financial institution at a rate of return that likely doesn’t even keep up with inflation. At least that’s how it seems to me.