How investing builds wealth
Investing offers the opportunity to earn returns in exchange for taking some risk. The higher the risk, the higher the expected returns over the long term. That’s why shares generally provide higher returns than bank interest.
Compounding occurs when your returns are reinvested and generate their own returns. Importantly, the sooner you start, the more time you have to benefit from compounding.
Example of how compounding builds wealth
Jane starts investing $4,000 each year at age 25 for ten years – a total of $40,000.
After ten years Jane stops saving and leaves her money invested until retiring at age 65. Sue doesn’t start investing until age 35. She invests $4,000 each year until retiring at age 65 – a total of $120,000.
If both Jane and Sue earn 7% annual returns after fees and taxes, Jane’s smaller but earlier investment of $40,000 will grow to $481,656. Sue’s larger but later investment of $120,000 will grow to only $436,873.
The risk and return trade off
Typically the greater the investment risk, the greater the potential return over the longer term
If you think you’re going to fall short of your retirement savings goal, consider investing your super in assets with the potential to earn a higher return, such as shares and property. Super is specifically designed for this type of long-term investment. From your first job until you retire could easily be 30 to 40 years, with perhaps another 20 or 30 years spent in retirement, giving you time to ride out the market’s ups and downs.
Even small differences in returns over a long time really add up. Here’s an example showing the risk and return trade off. As you can see, an extra 2% over 20 years earned an extra $10,000. How much could this translate for you?
|Rate of return for 20 years -reinvesting all returns ||Start with... |
|Finish with... |
|4% per year ||$10, 000 ||$22, 000 |
|6% per year ||$10, 000 ||$32, 000 |
The trade off for growth is losses in bad years
When investing in growth assets, it’s likely you’ll get a negative return or loss in four or five years over a 20 year period. When you get more than one bad year in a row you may think you made the wrong investment choice. However, a balanced or growth strategy would still be suitable for building your wealth over the long term1.
Only you can decide if the likely rewards are worth the risk.
A stable strategy involves investing more of your super in bonds or cash. This may suit people with a lower risk tolerance or who need greater security. For example, if you’re withdrawing your entire super in less than five years and want more certainty about how much money you’ll have.
Find out more in our Five Step Guide to Investing fact sheet
Managing risk through diversification
Investors often make the mistake of investing in last year’s best performing asset class, but this can backfire. Last year’s winner can often be next year’s loser. That’s why it’s important to diversify your investments. This means not putting all your eggs in one basket, but ensuring you spread your investment across different asset classes.
Diversification works because positive returns of some investments make up for negative returns of others. How much you invest in each asset class depends on your investment time frame, risk tolerance and investment goal.
Where should you invest your money?
Each one of us has different needs and attitudes when it comes to investing. Obviously, we would all like to make healthy returns, but there are other factors to consider, such as how long you’ll spend in retirement and the risk you’re willing to take.
If you have better things to do than worry about your investments, you can remain confident that we’ll look after your money through our MySuper default Lifecycle Strategy that reflects your changing risk tolerance as you grow older. Read more…
There's no ‘right’ investment choice. The best way to invest your super depends on your personal circumstances.