Australia is a country of investors, with nearly half of the adult population holding investments in addition to their super, reveals a recent survey.
There has always been a debate among people when it comes to investing vs. traditional savings system. Which is better? What should you choose?
Considering what we have come across in 2020, individuals feeling anxious about investing makes complete sense, and for those in ‘Team Savings’, this could be the win they were looking for.
Investing can be somewhat confusing at times. However, a short glimpse at the historical data reflects why investing always wins in the investing vs. savings debate.
A quick look over the past decade (2010 to 2020) indicates that S&P/ASX 200 grew 130% between 2010 and 2020.
That’s just one aspect of this debate. We have put together a list of the benefits of investing instead of savings for individual investors. Let’s get started.
Starting with the first benefit on our list, higher returns is one of the top reasons why people should invest instead of saving their money in a traditional account.
Considering the fact that S&P/ASX 200 witnessed a growth of 130% between 2010 and 2020, you could have more than doubled your money in less than 10 years. When you compare the same with savings accounts, the latter falls much short.
Traditional savings accounts offer an APY of under 1%. Your money loses its purchasing power over time. Additionally, you don’t have any control over your investment strategy. You’re limited to a steady, low rate of return.
Ability to beat Inflation
Inflation is the enemy of wealth. If your money is parked in savings accounts with interest rates lower than that of the current inflation rate, you’re already getting poorer with each passing day.
In order to preserve your financial resources, if not grow them, you need to put your funds in an investment product that beats inflation. Luckily, most of the investments, stock market-related or inflation-protected term deposits, offer inflation-beating results. You can be rest assured that you’ll have the same financial capacity over the coming years.
For people prioritizing savings over investing, the traditional interest rates on a savings account are already below the prevalent inflation rates across most of the last decade.
Create a sizable Nest Egg
One of the primary intents of investing is to create financial resources for long-term goals, such as retirement, real estate, child’s education, or starting a business.
You can achieve your financial goals by creating an investment strategy that aligns with these goals. For instance, if your goal is to save for retirement, investing consistently through mutual funds (index funds) will help you build a sizable retirement nest egg.
Similarly, you can opt for the security of bonds to save for short-term financial goals. You don’t have to take additional risks for your short-term financial requirements.
You can do the same through savings accounts, but you’ll have to save a lot more than what you would otherwise invest. We tried multiple scenarios, and in every single one of them, you’ll have to invest 2x, 3x, and even 5x times the money to achieve results similar to investing.
Strategic Diversification to reduce Risk
One of the primary concerns of individual investors is the risk involved in market-related investments. There is no doubt that stock market investments are subject to market volatility. You can grow your money manifold, but there’s always a possibility of losing your funds in stock market products.
However, diversification can help you reduce your investment risks. Financial advisors recommend investors to add stability to their portfolio by dedicating a portion of their portfolio to safer products, such as bonds and term deposits.
A diversified portfolio will not only help investors lower their risk, but they’ll also earn decent returns over time.
Conventional savings products, on the other hand, are protected against any risk.
You don’t bear additional risk, but the downside is a below-average rate of return.
Stock market investments provide higher liquidity in comparison to traditional savings products. All you need to do is to sell your stocks, or units in case of mutual funds, to withdraw your investments.
Most of the market-related products do not have lock-in periods (venture equity is one of the exceptions). However, you need to be careful about your effective tax rates or the impact of short-term capital gains taxes on your returns.
Most traditional savings products, such as term deposits, bonds, have specific maturity periods. Your funds are locked for the said duration. You may incur penalties for premature withdrawals of traditional savings.
Now that you are aware of the benefits of investing over savings let’s have a look at some of the most popular investment products.
- Stocks: Stocks are among the most popular investment options. When you purchase a stock, you receive fractional ownership in a company. There are several benefits of stock ownership, starting with getting a share of the company’s profit or surplus cash as dividends. Secondly, as the company grows, the price of its stocks grows in proportion, thereby giving long-term capital growth to investors. In order to invest in stocks, you’ll require a brokerage account for trading. You can choose an individual brokerage account or have trained financial advisors to manage your investments.
- ETFs: ETFs or exchange-traded funds are baskets of different financial assets packaged into a single product. Unlike mutual funds, you can trade ETFs like any other stock. ETFs provide the diversification you expect from a mutual fund without putting any limitations on the trading timeline or hold periods. Another benefit of ETFs is their low expense ratios. While the average expense ratio of ETFs listed on ASX 200 stands at 26 (0.26%) basis points, you can always find ETFs with expense ratios in-line with 10 to 20 basis points. You’ll need a brokerage account to purchase ETFs.
- Mutual Funds: Mutual funds are pools of investor money that invest in various assets, including stocks, bonds, and fixed-income instruments. You can choose mutual funds that target specific industries, asset classes or tracks a wider stock market index. In comparison to ETFs, mutual funds have a higher expense ratio. Some mutual funds may have a lock-in period, so make sure to understand the terms.
- Bonds, term deposits: Bonds and term deposits are fixed-income instruments that provide consistent returns against your capital. Starting with bonds, these could be treasury bonds, municipal bonds, or even corporate bonds. The idea behind bonds is to offer fixed growth to investors. When investing in bonds, make sure they’re investment grade (corporate bonds with BBB or higher ratings). Term deposits are bank deposits with specific terms. You can choose a term deposit term between three months and five years (longer in some cases). Term deposits with longer terms offer higher returns. Find out about the insurance status before opening a term deposit with a bank.
- Futures, Options: Futures and options are sophisticated investments suitable for investors with a decent understanding of the financial markets. In simple words, a futures contract is a promise you make to purchase or sell a commodity or stock at an agreed price in the future. An options contract provides the owner with a choice to buy or sell a stock or commodity at a specific price while the contract is active. There is no obligation to make a transaction in an options contract.
Choosing the right type of investment account is a critical aspect of your investing journey. Here is a list of some of the available options;
Investment accounts are managed financial accounts where advisors take care of investing for you. You can set financial goals, risk profile with these accounts. Depending on your portfolio, investment firms provide dedicated financial advisors.
For individuals investing for retirement, there are different types of retirement accounts available, including Roth IRAs, Traditional IRAs, and retirement solutions for businesses (SEP IRAs, SIMPLE IRAs), etc.
Brokerage accounts are required for trading. You can choose between managed and unmanaged brokerage accounts. Managed brokerage accounts come with experienced financial advisors trading on your behalf. There are some minimum investment requirements and advisory fees associated with brokerage accounts.
Investing is how you build and preserve wealth in the long-term. The trick is to clearly define your investment objectives and devise a strategy to achieve them.