6. Negative compounding happens when you don't beat inflation

We save money today so we would have money to spend in the future, how much we can spend in the future (how much goods or services we can buy) depends on the prices of these goods and services in the future.

Compounding is a powerful way to build wealth over time, for as long as the factor is positive. This means we are earning a return that is higher than the "Inflation Rate".

It becomes negative if we are not earning enough to offset the increase in prices as measured by inflation, over time, this loss will snowball to a significant loss in purchasing power.

This happens when you keep too much of your savings in a very liquid but low yielding savings account.

Take note that liquidity is a benefit that comes at the cost of not being able to keep pace with rising prices (see post on the cost of withdrawable anytime)

Rule of thumb on how much to keep in a savings account is an amount equivalent to three months average monthly expenses, so let's say your average monthly expense is 50,000, keeping 150,000 in your savings account is more than enough to cover almost all income shortfall, invest the excess in other higher yielding assets.

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