Investment returns may grab the headlines but saving money can provide a greater bang for your buck over the long term.
It comes down to the mix of risk and return as the industry moves away from selling investment products and towards goals-based advice.
Investment success is about far more than outperforming a benchmark based on a client’s risk tolerance. That plays just a small role in helping people build wealth in support of their specific goals over time, such as buying a house or funding their children’s education.
Saving can beat investing, with the right advice
Most people attempt to budget according to the Australian Securities and Investments Commission’s Australian Financial Attitudes and Behaviour Tracker.
Unfortunately, most of this activity doesn’t amount to much more than writing down some notes or checking bank and credit-card statements for unusual entries. This is similar to going for a walk around the block and calling it exercise. In contrast, a good financial planner providing high-quality holistic advice can have the same positive impact on someone’s financial future as a personal trainer can have on someone’s health.
A chart created from an analysis of the Moneysoft database reveals just how significant the impact of high-quality financial advice can be. It shows a near 50 per cent reduction, over 12 months, in clients’ discretionary (irregular) expenses, such as entertainment, travel, hobbies, credit-card repayments, etc.
Average client discretionary expenses were fairly flat over the first six months, before the benefits of financial coaching kicked in and clients’ changed their spending behaviour. We will delve more heavily into how financial planners help their clients achieve these changes – and where clients can direct these savings – in future articles.
Focus on returns but don’t neglect saving
The benefits of this type of saving stacks up well when compared with investing.
Let’s take a hypothetical client, Sara, who wants to buy her first home.
In this simplified example, Sara wants to save a 25 per cent deposit to buy a $650,000 apartment in Sydney. She has already saved half the deposit ($81,250) by living with her parents and adds an extra $1500 a month towards her target of $162,500.
She invests in a balanced fund, which we assume returns 5.7 per cent a year (based on hypothetical 10-year long-term returns over the decade ended December 2015 in the ASX/Russell Investments Long-term Investing Report).
At this rate, she believes she’ll reach her target in three years, based on a simple compound interest calculation. However, Sara doesn’t enjoy living with her parents and, as a Sydneysider, wants to get rich as quickly as possible by owning residential property. (Her adviser has had long conversations about the benefits of diversification, to no avail.)
She can target higher investment returns with her deposit but will need to take on more risk. She is also not guaranteed to receive 5.7 per cent a year.
If Sara is highly motivated, however, she can increase her saving rate by $500 a month (to $2000 a month in total) by cutting the majority of her discretionary spending and entertainment expenses. After the same three years, she would have saved $182,096 – an extra 12 per cent – which she would use on her mortgage.
To achieve the same result through returns, Sara’s balanced fund manager would need to post an annualised post-tax return of 10.1 per cent a year. This is not a realistic expectation, at least without taking on substantial investment risk far outside of her tolerance.
This is not to say successful investing isn’t important. The power of compound interest and the extra gains that even small increases in net returns can generate shouldn’t be underestimated, particularly for long-term savings such as superannuation. However, the bulk of household wealth remains outside of super, with the family home the largest store of wealth.
Savings plans represent an opportunity for financial advisers to establish long-lasting relationships with previously un-addressable clients, including younger people from Gen X and Gen Y. These new clients, in turn, can experience the immediate benefits of financial advice, regardless of how markets perform.