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We all have goals – whether you’re planning a big holiday, saving for a house or simply wanting to update your wardrobe for next season.
If you’re saving up for a big purchase, it’s easy to think you’ll get there quicker if you avoid spending your money on other things. ‘When we think about saving, we have a tendency to focus on the immediate sacrifices required to achieve our long-term goals,’ explains Dr Campbell Heggen, lecturer in financial planning at Deakin’s Faculty of Business and Law.
But where’s the fun in skipping meals and wearing old clothes? Making sacrifices isn’t the only way to boost your wealth. Using your existing savings to make smart investment decisions can go a long way.
Let’s say you’re starting out with $5000 in savings. Dr Heggen discusses how you could grow it over three years.
One of the best ways to grow your savings is by taking advantage of a savings account that pays compound interest, Dr Heggen advises.
Most transaction accounts used for day-to-day banking pay little to no interest on your deposits, ‘so depositing $5000 in a transaction account at 0.1% would earn you around $5 in interest each year’. But many savings accounts pay much more attractive sums through compound interest. ‘Compound interest means you earn interest on the money you deposit, and on the interest you have already earned – so you earn interest on interest,’ Dr Heggen explains.
For example, if you deposit $5000 in a savings account for three years at 2.75%, with interest paid monthly, you would earn $429.48 in interest after three years, giving you a total of $5429.48. ‘Of course, making regular deposits will boost your savings even further,’ Dr Heggen adds.
Of course, it’s important to read the fine print when choosing a savings account so you know what you’re signing up for.
'‘When we think about saving, we have a tendency to focus on the immediate sacrifices required to achieve our long-term goals.''
Dr Campbell Heggen,
‘If you plan on depositing a lump sum, without making regular contributions, a term deposit can be a good option,’ Dr Heggen says. ‘Term deposits offer a similar interest rate to savings accounts, with slightly higher rates generally offered for longer-term investments.’
A term deposit is a relatively low risk investment that involves depositing a defined amount of money into an account for a fixed term with a fixed rate of interest. If you have savings you know you’re not going to need to spend in the next, say, three years (and don’t want to be tempted), a term deposit can be worth considering.
If you invested $5000 in a term deposit at 3%, with interest paid annually, your funds would be guaranteed to grow to $5463.64 by the end of that three-year period.
However, be aware of the downsides before signing up for a term deposit, Dr Heggen warns. For example, penalties may apply if you wish to access your money before it matures.
‘Another way to grow your savings is by investing in shares,’ Dr Heggen says. The Australian All Ordinaries Index, considered the ‘barometer’ for our share market, had enjoyed an annual average return of more than 9% over the past 30 years. Over the past 10 years, however, it’s been closer to 4.5% per annum. ‘It is important not to set your expectations too high,’ Dr Heggen warns.
He says a good way to start on the stock market can be to invest in a diversified managed fund, in which an investment manager buys and sells shares on your behalf. ‘These forms of managed investments have traditionally provided average annual returns which are significantly higher than savings accounts or term deposits.’
For example, ‘if you invest $5000 in a portfolio of shares that provides an average annual return of 6.5% for a three year period, with the returns re-invested each year, the value of your portfolio would grow to more than $6040,’ Dr Heggen calculates.
‘Due to the benefits of compounding, investing for longer periods can have a significant effect,’ he adds. ‘For example, investing in the same portfolio returning 6.5% per annum for 5 years would see you portfolio grow to around $6850. Over a 10 year period, your initial investment of $5000 could grow to around $9385.’
These figures might look attractive, but it’s important to realise investing in the share market is considered higher risk than many other investment options and returns are not guaranteed, Dr Heggen warns. ‘For this reason, it is generally recommended that investing in the share market is more appropriate for longer-term savings goals. A good rule of thumb is that you should be willing to invest that money for at least five to seven years,’ he concludes.
Interested in improving your finance knowledge? Check out Deakin Business School’s range of courses.
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