Over the past week Australian shares were 2.7% lower. Shares in developed countries lost 0.6% with the US market down 0.7%. Shares in emerging markets lost 0.8%. The Australian dollar was 0.1% lower at 75.99 US cents. The 10 year bond yield in Australia was 0.09% higher at 2.38% while in the US, the 10 year bond yield closed the week 0.11% higher at 1.85%. The oil price lost 4.2% to 48.7 US dollars per barrel.
The broad message when accumulating super is simple: you contribute regularly, we invest well and your savings will grow. Creating a sustainable retirement income is a much more complex problem which we’ll talk more about another day.
So which is more important – contributions or investment earnings? It sounds like a “chicken and egg” style of question. It’s natural to think that contributions would be the largest overall contributor to your super balance at retirement but generally this isn’t expected to be the case.
To explore this we present a simple model of a 21 year old, Jim, who recently started working with a salary of $65,000. Jim’s salary is expected to grow at the rate of wage inflation. His contributions come from his employer which is currently 9.5% of his salary. He invests in the Mine Wealth + Wellbeing default Lifecycle Strategy. For this simple model we assume that the investment objectives are achieved each year, an unlikely scenario. Returns bounce around year to year but we do expect to achieve the stated investment objectives over the long term.
Source: Mine Wealth + Wellbeing
Our example shows that for many people, investment earnings could start to exceed contributions at just 35 years of age. From this point on investment earnings would be expected to continue to grow at a faster rate than contributions. Indeed in the final year of accumulation, investment earnings would be expected to be nearly four times the amount of Jim’s contribution for that year. The chart highlights the power of compounding your savings over many years.
The “crossover age” will vary depending on contributions and investment performance. Any outcome which increases the balance more quickly will increase the likelihood that investment earnings will exceed contributions and vice versa.
This doesn’t mean that super is all about investment earnings: if you never made a contribution there would be no balance to compound! So we still haven’t solved our own chicken and egg problem.
This example highlights the significant impact of investment returns on your super balance at retirement. We can also see that as people approach retirement the impact of bad investment returns becomes significant. This explains why members invested in our Lifecycle Strategy are automatically moved into lower risk investment options as they approach retirement age.
David Bell, Estelle Liu and Adam Shao