Until very recently, the idea of a high interest savings account in Australia didn’t make much sense.
We were in a period of record low interest rates with the Reserve Bank of Australia (RBA) official cash rate set at 0.10% from November 2020 until May 2022 as the central bank attempted to stimulate recovery from the coronavirus lockdowns that limited economic activity.
Since that first rise, however, the RBA has moved faster than ever to combat rising inflation, hiking the cash rate by over 4% in just three years.
Now, with higher rates likely to be around for a while, high interest savings accounts are a lot more appealing – but are they the best way to save your money and grow your wealth?
In this article, we explain when is the best time to use a savings account and how best to invest for the long-term.
Why were interest rates so low and why are they now rising?
Even before the pandemic struck in early 2020nterest rates had been falling in Australia due to lower consumption, weak wages growth, low inflation and high household debt.
Economies were slowing down and people were spending less, which was only exacerbated by global lockdowns
In light of these circumstances, the RBA began gradually lowering interest rates in 2011, which encouraged spending, lending, investing and borrowing.
In May 2022, however, the RBA lifted rates to help curb spending and runaway prices as inflation began to bite.
What do higher interest rates mean for my savings account?
To answer that, we must first think about why you need your savings to grow in the first place.
Most people understand the value of putting money away for the future, but often, that isn’t enough
Here’s a simple example. If you put $10,000 in the bank, you can be assured it’s safe and you’ll still have $10,000 if you decide to withdraw it in ten years’ time.
The problem is that in a decade, things will cost much more – check out the Reserve Bank’s Inflation Calculator to test this theory – and your $10,000 won’t be able to buy you as much.
That’s why high interest savings accounts were seen as an effective way to protect the value of your money.
If you left that $10,000 in a high interest savings account and didn’t touch it, it would appreciate a little bit more each year.
This was a great strategy when interest rates were higher, up above 10% like they were for much of the 1970s and 1980s.
These days, that same high interest account might give you a return of anywhere between 2% and 5% per year, and that’s before tax, which could cut that return in half again if you’re in a high tax bracket.
Essentially, Australians simply stashing cash in a high interest savings account are likely to see the value of their hard-earned money fall in comparison to the rising cost of goods and services (i.e. inflation).
If inflation is at 6% and your savings account is paying 4%, you have effectively lost money before taxes and transaction costs.
It is only through investing for the long-term do you have a chance at sustained wealth creation.
When to use a savings account
The rule of thumb with savings accounts is that they work best when you need something short-term – think three months to three years – and to make sure that your cash is working hard for you.
If you need to access your funds in the short-term, Stockspot generally recommends placing your money in cash exchange traded funds (ETFs) like the Betashares Australian High Interest Cash ETF (ASX: AAA).
Investing in a cash ETF offers the benefits of earning regular income while withstanding the volatility of the share market.
Cash ETFs have the advantage of not locking you into a set investing period and don’t come with the usual terms and conditions associated with a high interest savings account, like making regular deposits or keeping the balance above a certain amount.
You also won’t be penalised for selling the cash ETF (i.e. withdrawing the cash), as cash ETFs are highly liquid assets and can easily be bought and sold on the ASX.
What are the alternatives to a high interest savings account?
Interest rates have gone up and down, but returns on cash alone have lagged behind bonds and shares by about 2% to 4% per year on average for the last 30 years.
That might not sound like a lot, but $10,000 left in a savings account 30 years ago would be worth about $35,000 today compared to over $135,000 in Australian shares.
If you want to grow your money in a meaningful way, you’ll need to take some risk – and that means investing in assets like shares and bonds.
Yes, investing can be risky because the share market is volatile. Yet even with the market highs and lows over the past 30 years, the share market has still returned an average 9.1% per year in Australia and 10.3% per year in the US.
Cash, comparatively, returned an average of 4.2% per year over the same period.
Why savings accounts are not ideal for long-term investing
It is guaranteed that, when you invest in the share market, your money will go down as well as up. When that happens, it is known as a bear market.
A bear market is when shares fall at least 20% from their high, and there have been 12 of them in Australia since 1950.
The 9.1% p.a. return that Australian shares have made over the last 30 years includes several bear markets including 1987, 1994, 2002, 2008, 2015 and most recently 2020.
If you wait long enough, however, over time shares recover from bear markets and go higher. That’s known as a bull market.
Invest in shares for the long-term
A 9.1% p.a. return over 30 years will turn $10,000 into $135,000. If you topped that account up with another $250 per fortnight over that period, you’d end up with well over $1,000,000.
This is due to a wonderful thing called compound interest. You can test different scenarios using our compound growth calculator.
Money in the bank will either stay static or grow by tiny increments with interest. Investments, on the other hand, go up or down on a day-to-day basis while also accruing income along the way (through distributions/dividends in the share market).
The way to mitigate your risk is to understand the tenets of good investing and to diversify your portfolio.
For the long-term, look at diversification (i.e. having a mixture of investments that complement one another) as a way to reduce your risk significantly compared to picking stocks at random.
ETFs, like those offered by Stockspot, are a good option for the risk-averse investor as a single ETF provides exposure to hundreds of companies.
When you have a fully diversified Stockspot portfolio, you gain exposure to hundreds of different companies, while also investing in other asset classes.
You’re diversifying your investments across high growth/more risky assets like shares, but also more conservative/defensive assets like bonds and gold.
Stockspot recommends ETFs that are low in fees. This is important as paying just a few per cent per year in fees may not sound like much, but it could easily end up costing you more than $100,000 in the long run.
How much should I keep in a savings account?
It might be tempting to put all your money in a high interest savings account and lock it away.
Having some money set aside for a rainy day means you aren’t forced to sell investments if you need money when things go wrong, which could affect the long-term growth of your investments – and result in taking a loss on your original investment if you are forced to withdraw when markets are down.
A rule of thumb is that you should have between three to six months worth of living expenses saved for use in case of emergencies, medical expenses, home repairs, car repairs, fines, fees and other similar expenses.
As mentioned, you can also consider a savings account for any funds you may need in the short-term (between three months to three years).
Once you have that sorted, consider investing the rest of your extra cash in a diversified portfolio for medium to long-term investing goals (three years minimum to more than seven years.)
If you have time on your side, your money will be able to work for you and provide you with returns over the long-term.
