Risk, returns & timeframes
Yep, question time! But remember, this isn’t a test, and no one is keeping track of your answers. By working your way through a short quiz each day, you’ll test your assumptions about investing and build your knowledge. Before you know it, you'll have the basics you need to make your first investment on the US share markets.
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In the investing world, ‘risk’ generally means ‘fluctuations’
Risk sounds pretty scary, but it generally describes how much investments fluctuate over time.
Low risk: Savings
A savings account is one of the lowest risk places to store money because there is very little chance it will ever go down in value. Whenever you need that money, you know exactly how much will be available.
High Risk: Investing
If you own a home, you’ll have seen it change in value over 10-20 years. That’s exactly how the share markets work. If you need money on a particular day, you might have to sell your shares for less than you’d like, or less than you originally bought them for.
But you might still lose some money
Yes, if you’d taken your life savings and invested them in Kodak when everyone had a film camera, you may now have a lot less than you started with.
Over the next few days, we’ll teach you about some investing principles that might help reduce the risk of losing money in the long run (think: don’t put all your eggs in one basket).
It is important to note that since the share market crash in the 1980’s, laws around investing have changed dramatically. Even so, it’s always wise to do your research and invest through reputable, licensed providers. Did you know that by law, financial advisors have to be registered? You could think about talking to one of these experts if you're looking for financial advice.
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Short term = low risk
Everyone worth their salt will tell you to keep your emergency funds in the lowest risk place you can find. When your car breaks down or you need an urgent tooth extraction, you want to get quick access to that money (without having to pay break fees), and you want to know exactly how much is going to be there.
Important: While dodgy finance companies of the past may have begged to differ, there is no such thing as a low risk, high returns investment. No. Such. Thing.
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Long term = higher risk
If you’re working towards a far-off goal, you can afford to wait out the ups and downs of investing. Why? Because this isn't money you need any time soon. So, on any given day, you might not get out what you put in. Could be more, could be less.
In the long term, you don’t want to save your money, you want to grow it
The goal of a savings account is to preserve your money, not to grow it, and you pay a high price for a stable account balance. For a start, the interest rate you get is dwarfed by the average returns of the share market over the last 20 years. The second kicker is inflation. At the current inflation rate, the value of your money actually decreases each year, which reduces the value of already low interest rates.
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Inflation wipes out most of your interest, leaving you with about the same as you started with
According to Sorted’s savings calculator, the disappointing news is that when you take into account inflation, after 20 years in a savings account, your money has earned you $514. On the other hand, even after numerous market ups and downs (and the Global Financial Crisis!), if you’d invested the money in the share market (on average) it would have more than tripled.
On Tablet & Mobile, scroll to see full table content below.
2.5% interest
7.96% average returns
FYI, we found the average annual share market returns of 7.96% from Investopedia, and used Sorted to calculate the after inflation returns. They explain their assumptions here.
We’d love to give you the answer, but it’s a personal choice.
The numbers show that you sacrifice a lot just to have a stable account balance. In the short term, it makes sense, in the long run, not so much.
But it’s not all facts and figures
Choosing where to put your money is as much of an emotional decision as it is a logical one. Over the last 20 years, the share markets may have returned around 7.5% on average, but there’s more to the story:
The share markets didn’t go up in value by 7.5% every year. Some years, they went up 25% and about one year in five, they dropped in value.
There’s no guaranteed return
No one can tell you what the average returns from the share market will be over the next 20 years. We do know that since they began, they’ve gone up in value over long periods of time. But how long is anyone’s guess.
But the great news is, it’s not all or nothing. You can spread your long term savings over savings, term deposits and investments and you can change up that mix over time #StartSmall.
More on this to come!
Food for thought.
Every day, we'll look at simple things you can do to get a little closer to investing.
When's the last time you logged into your internet banking and thought really hard about your savings account?
Since we know that the interest you earn on your savings barely keeps up with inflation, let’s sort out how you could better put this money to work. First decide how much you need on standby for the short term, then divide the rest into money for medium and long term goals (e.g. emergency fund, holiday savings, house savings, kid’s education fund etc).
- How much do you have right now to put in each category?
- How much can you add to each category each month?
If your bank doesn’t charge fees on your savings accounts, it may be a good idea to open a savings account for each category, and add your monthly savings directly into each account.
Watch it in action!
In this 5 minute video, we explain compound returns and how inflation eats the interest on your savings.