There’s a lot of misunderstanding about superannuation given that it’s one of our most important lifetime financial investments – or it should be. We sort out some fact from fiction and answer some common questions about super.
How does superannuation work?
Superannuation is your primary way of saving for retirement. If you have an employer, the government mandates that they pay a certain percentage of your earnings into your fund. There are many different superannuation funds out there and types of super funds (i.e. industry funds versus retail funds). They all pool their contributions and then invest the money based on the investment strategy the particular fund has created for its members.
How do I choose my super fund?
Some employers limit your choice of funds, so ask your employer if you have a choice about the fund into which they pay your super. If you do, get advice from a financial professional to help you choose the best option for your personal circumstances and goals.
How do I choose investment options?
Most super funds give you a choice of investment options that include various types of investments (such as shares in stocks, property, or cash). Your choice impacts your risk for market ups and downs, as well as how fast your investment will grow. If you’re not a financial professional, it really helps to talk to someone who is to help you work out what your best options are.
How risky is super?
If your superannuation balance is going down and you’re panicking, take a deep breath. Remember that super is all about time and the value of your investments will increase over time. Yes, all investing involves some risk, and typically there is a direct relationship between the amount of risk involved in an investment and the potential amount of money it could make. However, investing is still one of the best ways to build your wealth over the long-term. Remember also that good superannuation fund managers build market volatility into their long-term strategy through diversification.
TIP: Simply avoiding some common mistakes can help you reduce risk and maximise your retirement savings. Download our free eBook on Top 10 Super Mistakes and How to Avoid Them.
What is diversification?
Diversification involves investing in a number of different asset classes – for example, shares, property and bonds. Having a diversity of asset classes and industries in a portfolio helps investors to ride out volatility in market cycles.
What’s the secret to building a super nest egg I can retire on?
In a word, time. When you have a diversified investment portfolio, such as a superannuation account, there tend to be more successful investments (“winners”) than those that have underperformed or lost money over time (“losers), and these help balance each other out. Importantly, the more time you have the more you and your portfolio can benefit from the magic of compound interest.
What is compound interest?
Imagine you place one checker on the corner of a checkerboard. Then you place two checkers on the next square and continue doubling the checkers on each following square. If you've heard this brainteaser before, you know that by the time you get to the last square on the board—the 64th—your board will hold a total of 18,446,744,073,709,551,615 checkers.
While there’s no guarantee you can double your money every year, the principle behind this (known as “compounding”) is important to understand. When your starting amount is higher, your increases are higher too. Over time, this can really add up.
EXAMPLE:If you earn 6% on a $10,000 investment, you'll make $600 in the first year. But then you start the second year with $10,600—during which your 6% returns will net you $636. This is a hypothetical example that does not take into consideration investment costs or taxes. In the 20th year of this example, you'll earn more than $1,800—and your balance will have increased more than 200%.
A caveat: reinvesting is key
If you take your earnings out of your account and spend them every year, your balance will never get any bigger—and neither will your annual earnings. So instead of making more than $20,000 over 20 years in the hypothetical example above, you'd only collect your $600 every year for a total of $12,000. If you instead leave your money alone, your "earnings on earnings" will eventually grow to be larger than the earnings on your original investment – and that’s the power of compounding!
We can support you to maximise the benefits of your superannuation. Call us anytime on (02) 8268 2900 for an obligation-free chat.
Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Please consider whether the information is appropriate to your circumstance before acting on it and, where appropriate, seek professional advice.