Getting into the habit of saving can be hard. Australia isn’t a cheap place to live and making sacrifices to put a chunk of your money into a savings account is never easy.
Yet there is a big catch. If all you’re doing is putting your money into a high interest savings account, the strategy you’re signing yourself up to is far from a safe one over the long run.
What the? Cash in the bank not safe?
Interest rates are at an all time low, which means you’re making less and less on interest each year.
A savings account will give you a return of between 1% and 3% per year (if you’re lucky). And that’s before tax which can cut that in half again if you’re in a high tax bracket. Meanwhile the cost of essentials like food, healthcare, housing and education are rising by more than 5% per year.
Source: McCrindle Research
The whole point of saving is to be able to afford the stuff you want later. When you put $100 in the bank you’re pretty confident it’s safe and it will still be worth $100 by the time you can take it out in 10 years.
That’s true, but the things you want to buy in 10 years will cost much more. Whether that’s a house, healthcare, school fees or a holiday.
The equation is simple, if the money in your savings account is only earning 1% to 3% per year in interest, you’re actually getting further and further behind over the long run because your lazy cash isn’t keeping up with what you’ll want to buy 10 years from now.
So where should I put my money?
There’s good reason to keep some money in cash. We recommend our clients keep at least 6 months worth of living expenses available in the bank in case something out of their control goes wrong – like unexpected medical expenses.
Above this, if you have time on your side your money will work harder for you if you invest it.
|Returns over 30 years to 30 June 2016|
|Cash (bank deposits)||6.9%|
Over 30 years cash has done ok, but still lagged bonds and shares by about 2% to 3% per year.
That might not sound like a lot but $10,000 left in a savings account 30 years ago would be worth about $75,000 today compared to over $150,000 in Australian shares.
Shares vs cash in the bank
Yes, investing can be risky because the share market is volatile. It goes up and it goes down, if you’re a cautious type this can be a scary concept.
Yet even with the market highs and lows over the past 10 years (and including a big financial crisis) the share market has returned an average 5% per year in Australia and 7% per year in the US. Both have beaten the returns in cash over the same period which lagged at 4% per year.
That’s right, even in a very bad decade, shares have beaten cash!
But what if shares fall?
You’ll often hear that past performance isn’t a reliable indicator of future performance. Certainly over weeks, months or even a few years this is true. We’re also prone to looking back at the recent past and thinking that will continue – but the recent past is a very unreliable predictor of the near future.
What is a bear market?
One guarantee when you invest is that your account will go down in value from time to time. Sometimes the value will fall a lot and go into a ‘bear market’.
A bear market is when shares fall at least 20% from their high and there have been 12 of them since 1950. That’s about 1 every 5 years.
Over time shares recover from bear markets and go higher. That 9.6% return that Australian shares have made since 1986 includes several bear markets including 1987, 1994, 2002, 2008 and 2015.
Shares pay off over the long run
A 9.6% return over 30 years will turn $10,000 into $155,000. If you can top that account up with another $500 per month over that period you’d end up with $1,000,000. This a wonderful thing called compound returns, it’s a topic we write about regularly.
However a lot of people still leave their money in a bank savings account for decades, thinking it’s safe option.
Grow your savings the smart way
Stockspot is Australia’s largest digital investment adviser. We can help you build and manage a personalised portfolio tailored to your financial situation and your goals. It’s professional investment advice without the high costs of seeing a human adviser.
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Main image: Qwedgeonline via Flickr