Save Hard, Save Early
Earlier in the year I wrote a Money article 'How saving helps you take control of your life', exploring the fundamental reasons why it's important to save and to do it early. But the confines of a 500 word article don't leave much room for explanation and the points are important enough to warrant it.
If you're just turning your mind to saving, investing or your superannuation account, the principles are everything.
First point is the maths of saving. Albert Einsten once said that 'compound interest is the eighth wonder of the world'. But for Australians it's an understatement.
In the article I gave an example of a judicious amount of early year saving leaving you in a position to both spend and save more five years down the track. But to keep things simple, I ignored tax and the rules around super.
Our super system is designed for regular, periodic saving, not catching up later. You can take $25,000 (soon to be $30,000) of your income each year, stick it in super and only pay 15% tax on it (these are called concessional contributions and are done by way of salary sacrifice or claiming a tax deduction). But you can't save your concessional contribution cap and use it later.
If you start work at 25 and make only the compulsory contributions, you'll have a harder time catching up to someone making voluntary contributions on top. It's not only the power of compounding working against you; catching up might require you to make non-concessional contributions. In other words, you have to pay full freight tax on your income, then stick it in super.
If your compulsory super is $10,000 a year, you've got $15,000 (of the $25,000 cap) you can contribute from your pre-tax income. Effectively, you can set aside $150,000 of income over a decade, paying 15% tax instead of your marginal tax rate (which could be almost half your income).
A decade later, with some decent sharemarket returns, you might have a $350,000 super balance and be well on the way to a comfortable retirement.
Contrast that with sticking to the bare minimum (compulsory super). You'd have a $140,000 super balance, so you'd need $210,000 to catch up. Because you can only contribute $15,000 from your pre-tax income (I've ignored inflation and indexing) the bulk of this has to come from income on which you've paid tax.
On the top marginal tax rate that's $400,000 pre-tax. It's a big difference (compared to $150,000) and helps explain why so many Australians will struggle to meet their retirement goals. They're just not saving early enough, or hard enough, for the powerful combination of tax benefits and compounded returns to take effect.
Of course, saving isn't just about retirement. Saving early (both inside and outside super) gives you flexibility, security, less stress and lots of options for your life.
When you're young, or youngish, the future can seem boring compared to an overseas holiday or a big house. So I'll throw in some upside possibilities to add a touch of excitement.
One of the great things about having savings is being able to buy things when they're cheap, especially growth assets like shares. Picture an employee in their late 20s with $25,000 in super post the 2007 credit crunch. Sensing opportunity, they salary sacrifice to bring their total super contributions up to $25,000 in each of 2008 and 2009. It's income dependent (since these figures include compulsory super) but this might require a spending sacrifice of $7,000-$10,000 a year.
With a $75,000 balance they've got the scale to set up a SMSF with e-Superfund, and establish a simple portfolio based on Intelligent Investor recommendations, II Value Fund and Magellan Global Fund (or simply our model Aggressive Portfolio, if it existed at the time).
Admittedly the timing is perfect, but come June 2014 they'd have a super account in the ballpark of $200,000. Chart 1 illustrates how an effort to save and an interest in super can give a big result.
Even if contributions were cut back to 'compulsory only' – allowing room for extra holidays or a larger house – this super account is heading for a $2-3m balance by retirement.
Of course, if you're young you can't touch your super, so you'll need something outside of it (see What should I do about super). Remember also that life isn't a superannuation account or a compounded interest calculation. Saving sensibly, not ridiculously, is the name of the game.