If you’re putting money aside for long term savings such as that dream holiday, your kids education, or general long term savings, good on you! Regularly setting aside small amounts of money is a great way to save for your financial goals and build your wealth. However, if you’ve got this money sitting in a bank account, you could be short changing yourself.
Next to stashing your money under a mattress, a bank account is the safest place to keep your money, and carries the lowest amount of risk. However, the flip side of low risk is that you can only expect low levels of returns on your money. The general rule of thumb is that the lower the level of investment risk you take, the lower returns you can expect. The higher level of investment risk you are willing to take, the higher potential level of returns you would expect. With a bank account being the lowest possible risk option there is, you can only expect very low levels of returns for your money. There are some benefits of bank accounts though, one of them being thatgenerally speaking, you can access your money instantly, which makes it a great place to keep an emergency cash fund, to cover those unexpected situations that can arise when you need to access some cash fairly quickly.
However, for planned, longer term savings such as your kids’ education or general long-term savings, a bank account may not the best place to keep your money.
During a recent phone call with a client, she explained how they were setting aside a regular amount (around $50 per month) in a bank account for each of their kids, to help with University fees or similar one day.
It was encouraging to hear that they’re making smart financial decisions and planning for their future, however, they were making a very common mistake with this money. The kids were 8 and under, meaning there was likely at least 10 years until this money would be needed to help fund education. Over this time-period, regular savings like this are likely to grow a lot bigger if it is invested into a diversified portfolio of assets including shares rather than sitting in a bank account. The accumulated effect over this length of time is worth paying attention to.
Using this example of saving $50 each month over a 10-year period, the additional potential benefit of saving this money into a diversified portfolio with a balanced level of risk, compared to saving it into a bank account, is around 25% more money after the 10 year period.
The common response from people when discussing this concept, is that while that sounds nice, they don’t want to do anything too risky. Investing into anything carries a level of risk – there is even some risk involved with a bank account, although the risk is small enough that people generally don’t consider this or worry about it. While investing into assets other than a bank account does carry additional risk, it’s a calculated risk, and it’s about finding out what level of risk you are comfortable with.
One of the key things to consider here is your investment time-frame. We know that share markets will go up and down, they always do, but over the longer term the trend is up which helps to grow the value of your money. If you have a medium to long term investment time frame (say 5 – 10 years or more), then you have got plenty of time to go through the market dips and bumps and recover from this and see some long-term growth. In this situation, it’s probably worth taking on a slightly higher level of risk to achieve a higher level of return than what you get in the bank. However if you know that you will need your money in say 2 years time, then this is a reasonably short investment time-frame and does not give you very long to recover from any dips along the way before you will need to withdraw your money. With this shorter time frame, it may be best to keep the money in a bank account or a similar, conservative type of investment.
If you do want to look at options outside the bank, it does not mean you have to take on a very high level of risk. There are plenty of things that good investment managers and advisers will do to minimize the risks, such as spreading your money around wide enough across a range of different types of assets, as well as spreading it across enough individual investments within that asset type, so that if something happens to an individual company within your portfolio it won’t matter too much, as it’s such a tiny portion of your total investment. Or if the value of one type of asset in the portfolio decreases, you’ve got a mix of other assets in there which will hopefully be performing better.
It’s important to understand some of these investment concepts, as this knowledge and understanding will help you to determine the level of risk you are comfortable with – whatever you do with investing, you want to make sure you are comfortable with it, and that you understand it. As an investment adviser the last thing we want to see is a client invested into something they do not understand and that is too risky for them. What will often happen in this situation is that if the share markets hit a bit of a bump or go down, this type of investor will panic and will want to sell their investment at a time when the markets are down, meaning they will loose money, rather than holding onto the investment and waiting for the share markets to rise again.
So if you’ve got long term savings in a bank account, it’s time to consider whether the bank is the most appropriate place for that money. If your investment time frame is 5 years of more, it’s probably worth taking a calculated risk, and considering other investment options that will likely result in higher levels of returns on your money, which will ultimately lead to a bigger pile of money at the end of the day. If your time-frame is between 2 – 5 years, you can also consider investments outside the bank, although in this instance you’ll probably want to consider options at the lower end of the risk scale given the lower time-frame involved.
Ilumony has a great range of very well diversified portfolios that suit all types of investors, from those who just want to dip their toes into the water of investing outside the bank account, to those who are ready to dive in head first. We’ve made it so quick and easy to get going with an investment portfolio via our online platform. If you want some help understanding these investment concepts and deciding what level of risk you are comfortable with, we’ve got qualified, highly experienced Authorised Financial Advisers on hand to discuss this with you.
Disclaimer – Rachel Strevens is an Authorised Financial Adviser (AFA) and Director of Ilumony Ltd, a company providing financial services and advice on KiwiSaver and investments. A copy of her disclosure statement is available free of charge on request from firstname.lastname@example.org
Information provided in this article is of a general nature only, and is not intended to be personalised financial advice.