Paul's Insights: Is it even worth having a savings account?
In the world of investing, risk equals return. So, it’s little wonder that savings accounts pay such low interest. Cash deposits are extremely safe, especially as the balance (up to $250,000 per account holder, per bank) is guaranteed by the federal government. And unlike an investment in, say, shares, your account balance won’t fall in response to market movements.
That’s not to say cash savings are problem-free. Without the benefit of capital growth, the purchasing power of your money will be whittled away by inflation over time. This is why it makes sense to hold some cash – but depending on your life stage, it shouldn’t account for the bulk of your portfolio.
The problem can arise when we use cash to save for personal goals. As first home buyers would know, when interest rates fall, your own deposits have to do more of the heavy lifting to grow the balance. On the flipside, low rates apply to mortgages too, and as lenders like to see 3-6 months of genuine savings, it’s still worth keeping up with a savings regime.
For anyone working towards a longer term goal, relying on cash savings can slow your progress. It’s possible to earn 1.5% on savings accounts though this usually means meeting strict conditions around the number and/or value of regular deposits. Fail to meet these, and you could earn a ‘base rate’ as low as 0.1%.
Term deposits are slightly more attractive but be prepared to hunt around. Judo Bank for instance has a 2-year rate of 1.45%.
Either way, cash savings have another significant drawback. The interest you earn is fully taxable, and a high income earner can mean close to half their returns in tax.
If you have a medium-long range horizon for your goals, it can be worth looking at other options like low cost income funds as well as exchange traded funds. Yes, this can mean taking on more risk. The trade-off is the potential for higher long term returns including capital growth. In many cases, investors also enjoy tax savings on the regular income that ETFs deliver plus any capital gains when they sell out in the future, which helps to keep after-tax returns high.
Paul Clitheroe is Chairman of InvestSMART, Chair of the Ecstra Foundation and chief commentator for Money Magazine.
Frequently Asked Questions about this Article…
Savings accounts offer low interest rates because they are extremely safe investments. The federal government guarantees cash deposits up to $250,000 per account holder, per bank, which minimizes risk but also limits potential returns.
Inflation erodes the purchasing power of your money over time. Without capital growth, the value of your savings in a bank account can decrease in real terms, meaning you can buy less with the same amount of money in the future.
Yes, it's worth keeping a savings account for short-term goals, especially since lenders like to see 3-6 months of genuine savings. However, be aware that low interest rates mean your deposits need to work harder to grow.
Relying solely on cash savings for long-term goals can slow your progress due to low interest rates and the impact of inflation. Additionally, the interest earned is fully taxable, which can significantly reduce your returns.
Yes, for medium to long-term goals, consider options like low-cost income funds and exchange-traded funds (ETFs). These options may involve more risk but offer the potential for higher long-term returns and tax savings.
Investing in ETFs can provide higher long-term returns, including capital growth. They also offer tax savings on regular income and capital gains, which can help keep after-tax returns high.
Term deposits typically offer slightly higher interest rates than regular savings accounts. However, you may need to shop around to find competitive rates, such as Judo Bank's 2-year rate of 1.45%.
When choosing between cash savings and other investments, consider your risk tolerance, investment horizon, and financial goals. While cash savings are safe, other options like ETFs may offer higher returns and tax benefits over the long term.
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