One percent doesn’t sound like a lot, does it! I mean whether you get a final mark of 88% or 89% in an exam is not going to change the fact you received a high distinction for the test. But in the world of investment market returns, every one percent counts, especially regarding your superannuation. The difference between a 7% pa. or an 8% pa. average return over the course of time makes an enormous difference.
How much difference does 1% really make.
Age 25 years old 25 years old
Salary $50,000 indexed at 2.5% $50,000 indexed at 2.5%
Superannuation contribution 10% of salary 10% of salary
Superannuation earnings 7% per annum 8% per annum
Annual fees 1% of account balance 1% of account balance
Account balance at age 65 $762,162 $921,145
The above example demonstrates the power of compound interest in the life of a young super accumulator over the course of his/her working life.
A 7% pa return sounds ok, especially when current interest rates are at historic lows. But imagine for a moment by settling for an investment return of 7% and not looking at what other investment opportunities exist, you miss out on the possibility of generating 8% pa returns. It may not sound like much, but the cumulative difference over 40 years is $158,983.
Don’t neglect the future you by settling for average investment returns, without understanding the potential returns that can be generated.
There are three important questions for you to consider if you want to make compound interest work powerfully for you:
1. How is my superannuation invested?
If you have not previously selected an investment option within your superannuation fund, chances are you are in a default investment option. This option typically holds a mix of assets e.g. shares, property, cash and fixed interest deemed appropriate for your age and stage of life. But this default option may not align with your own investment objectives and attitudes towards risk/return.
It is growth assets e.g. shares and property that form the engine of capital growth within your portfolio and have the ability to produce income that increases at a rate greater than inflation. Your exposure to growth assets over the long term will be the key driver of investment performance. Yes, shares can be volatile in the short-term, but investing in quality companies that have comparative advantage in their field, have strong management teams and healthy balance sheets rewards investors over the long-term. According to the Vanguard 2017 Index Chart, Australian shares have generated 8.4% p.a. over 30 years till 30 June 2017 as measured by the S&P/ASX All Ordinaries Accumulation Index.
2. How much am I contributing to super?
If you are working as an employee, your employer will be paying 9.5% of your gross salary into your superannuation fund, called the Superannuation Guarantee (SG). While this is a good start for building your long-term retirement savings, you can also increase your super through making additional contributions in the form of concessional contributions (e.g. salary sacrifice) and non-concessional contributions (after-tax contribution). By making additional contributions, you are increasing the available balance that investment returns are compounding on. The earlier you commence making additional contributions to super, the more valuable those contributions become due to the time value of money.
For most people, superannuation is the most tax effective vehicle for long-term wealth creation and thinking about making extra contributions to superannuation makes a lot of sense. However, due to the complex rules surrounding superannuation you should seek professional advice before making additional super contributions.
3. How long am I investing for?
It is tempting to look at investment returns in 1 year ‘bite size’ pieces when the annual statement arrives by post and file it for another day. However, for Millennials likely to be working till they are age 70, with life expectancies beyond age 90, it is the average annual returns generated over the next 10, 20 or 30 years that are of much greater importance.
Keeping the long-term nature of superannuation and retirement savings at front of mind is important and may act as a safeguard against making knee jerk reactions to short-term market movements, that inevitably lead to poor decision making.
1% can make a big difference, if you are currently disengaged with your superannuation maybe this is just the ‘nudge’ you need to have another look and see whether your portfolio is invested according to your goals and objectives. If you need assistance in reviewing your superannuation or have any other questions, please don’t hesitate to contact our office.