Paul's Insights: Is it even worth having a savings account?
The Reserve Bank's decision to cut the official cash rate to a historic low of 0.1% was something of a blow for anyone trying to grow cash savings. But there are still valid reasons to hang onto 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.