Shares v savings accounts: The risks and rewards
It’s a crazy age when a saver gets 1 per cent for locking up their money with a bank for 12 months. If anyone offers you much more, be clear on this: you’re taking a risk.
And when it comes to where you put your money, you should understand something about the safety of that organisation and also what the inflation rate is.
Once upon a time (not all that long ago), banks would offer you 5 per cent for locking up your money for a year or more. But in those days, inflation might have been 3 per cent, so your real rate of interest (or rate of return) was only 2 per cent. The real rate of interest is the advertised rate of interest minus the inflation rate.
Right now, the inflation rate for the July quarter was actually negative 0.3 per cent. So the real rate of interest on a term deposit would be +1.3 per cent.
However, until the Coronavirus came to town, the average inflation rate was around 1.7 per cent, so if your saving interest rate was only 1 per cent, you were actually losing out (in real terms).
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Lots of older Aussies look around and see financial institutions offering 4 per cent, 5 per cent or even more to invest their money there. While some of these businesses will return your money and pay the interest they’re promising, things can go wrong and you can lose the lot.
There’s a simple rule that says: “The higher the promised return, the higher the risk.”
In Australia, the big appeal of saving with a bank is that for up to $250,000 of your deposited money, the Government guarantees the safety of your deposit.
That’s why those people who are scared to invest in stocks (which are risky) might put their life-savings into two separate accounts at two separate banks if they have, say, $500,000.
Older Australians have to be careful about where they put their money because, while the stock market is risky, sometimes it can be safer in the long term, provided you can live through the ups and downs of the market.
This chart shows how an exchange traded fund such as IOZ that buys the top 200 stocks on the Australian stock market, might have affected someone’s savings.
If on the first of December 2010, you put $100,000 into this ETF, right now if you sold out of it, your nest egg would be worth about $125,000. And each year you would’ve received about $4,500 in dividends, which is a return of about 4.5 per cent.
However, around September 2011, your $100,000 had fallen to $82,000 because the market was spooked about America losing its AAA-rating from credit-rating agency S&P.
That said, over time, good news trumped bad news and your nest egg grew again. That’s what stock markets do.
In the short term, being in the share market can be risky but, over time, provided you’re in good stocks (and our top 200 stocks are good stocks as a group), the returns are generally positive and rewarding. But that’s because they’re risky in the short term.
History says our stock market has, on average, risen seven out of 10 years. And in a study by Ashley Owen, who’s a share market historian, between 1883 and 2010, there were 1,200 separate 10-year periods and our stock market has never delivered a negative absolute return. That includes the impact from stock prices and the dividends they pay. That means investors had never seen their capital or nest egg shrink over a 10 year period.
So the market can be risky in the short term but is pretty reliable in the long term. I hope this helps you understand what you risk and what you get back a little better.
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