Is it better to save inside or outside super?

Landed your first full-time job? Congratulations! Now that you’re hard at work, it’s important to make your money work hard also. So where should you stash your cash? We compare savings accounts, ETFs and super.

No matter whether you’ve just graduated from high school, TAFE or uni, your first full-time wage can seem like a small fortune. And it can be tempting to spend the lot. But there are good reasons to get into the habit of saving part of each pay packet.

Canstar’s 2021 Consumer Pulse Report found one in four Australians spend more than they earn, something that can usually only be done by loading up with debt. But saddling yourself with debt for purchases of no lasting value from a young age can make it harder to get ahead financially. A solid chunk of your pay can end up going towards interest charges – great for your lender but not so good for you.

There are other worthwhile reasons to start growing savings from an early stage. These include:

• More time to benefit from compounding returns

The sooner you start saving, the sooner you benefit from compounding returns. This is where your returns start to generate returns of their own, helping to grow your savings pool.

• Kick personal goals – debt-free

It’s a fair bet you have plans for the future – maybe buying a car or taking a holiday. Whatever your goals, growing savings can help you tick off your bucket list sooner.

• Lenders love to see a track record of savings

Chances are, at some point you’ll need to apply for a loan, be it to buy a car or first home. When that happens, lenders will want to see a healthy history of savings. It demonstrates you have the financial discipline to manage loan repayments.

So what are your main options for stashing your cash? There is no shortage of options, however, we’re going to focus on three key choices – savings accounts, exchange-traded funds and superannuation. They are all well-regulated investments that let you get started even if you have limited funds to invest.

Savings accounts

Savings accounts are a no-fuss option to kickstart a savings plan and steadily grow your balance over time.

The pros

• Savings accounts are very safe. Under the Financial Claims Scheme (FCS) your money is guaranteed up to $250,000 per account holder, per institution.
• It’s easy to put savings on autopilot by setting up a regular transfer of funds from your everyday account to your savings account.
• You don’t have to deal with the volatility that can come with having your money in other assets such as shares.

The cons

• Savings accounts are very low risk, so you won’t earn a high return. In particular, you won’t benefit from capital growth – an increase in the value of your underlying deposits. Inflation can also see your savings potentially go backwards.
• Interest earned on savings is fully taxable. If you’re a middle-income earner with an annual income between $45,001 and $120,000, you could pay 32.5 cents in tax for every $1 earned in interest income. This further reduces what’s likely to be a low return.

→ Related:  High interest savings accounts in Australia

Exchange-traded funds (ETFs)

Exchange-traded funds (ETFs) offer an easy way to invest in a broad basket of shares, with the potential to earn long-term capital growth plus ongoing distributions.

The pros

• ETFs provide instant diversity, spreading your money over a wide range of underlying shares.
• You can start investing in ETFs with as little as $500.
• ETFs can be tax-friendly – both when you sell the ETFs and in terms of ongoing income.
• The long-term returns can be strong.

The cons

• Most ETFs aim to replicate the returns of a particular market index such as the ASX 200 – the leading Aussie sharemarket index. That’s great if the index rises in value. But if the underlying market falls, the value of your ETF(s) will likely fall by a similar percentage. So you need to be prepared for that risk. ETFs can also be quite volatile.
• You can expect to pay brokerage each time you buy/sell ETFs. It’s worth shopping around for a broker as some of the cheaper online brokers charge less than $10 per trade.

→ Related: Highest return ETFs in Australia 2022

Superannuation

Superannuation is designed to be a very long-term investment to help fund your retirement.

The pros

• There can be tax perks associated with adding extra money into super. For example, if you salary sacrifice the money you add into super is taxed at 15% instead of your marginal tax rate. Plus, if you make an after-tax contribution you may also be able to claim a tax deduction.
• Many super options invest in a variety of asset classes so you can achieve a good level of diversification.
• Super can deliver high long-term returns.
• If you are saving for a first home, the First Home Super Saver (FHSS) scheme can let you use super to grow a deposit. Under the FHSS, you can make voluntary contributions to super – up to $15,000 each financial year, that count towards your deposit. The overall limit is $30,000 across all years, rising to $50,000 from 1 July 2022.

The cons

• Your money is typically locked away for a long time. You won’t be able to access it until you meet a “condition of release”. For most people that will be at age 60, although this may change in the future. Of course, you may be able to access some of your money for a home deposit under the FHSS.
• There are limits to how much you can add to your super and if you exceed these caps you could be penalised.

→ Related: Best performing super funds on Canstar’s database

How each option stacks up

Canstar crunched the numbers based on a 21-year-old earning $62,811 to see how the options compare. As the table below shows, tucking away 10% of your income in a savings account paying 3%pa interest could see you accumulate $27,367 after five years. Use an ETF instead, and you could accumulate $28,664 based on past five-year average returns of 6.74% annually.

Over a five-year timeframe, super comes up trumps. Invest 10% of your income into super, and you could accumulate $32,542 after five years. This reflects the higher returns of super which,  based on the average annual five-year performance of growth investment options available for a 21-year-old on Canstar’s database, have averaged 8.37% a year.

If you have a 10-year savings plan, however, ETFs top the leaderboard as over the past 10 years ETFs have notched up annual gains averaging 8.71%. For superannuation the calculations are based on the five-year returns of 8.37%.

Assuming you save 10% of your income, you could amass $59,016 over 10 years with a savings account, a figure that rises to $61,442 for super or an impressive $71,262 with ETFs.

Impact of regular saving in different investment types

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Source: www.canstar.com.au. Prepared on 16/06/2022. Scenario for superannuation begins at the start of the 2021-22 financial year and is based on a 21-year-old with a starting balance of $5,912 (per APRA Annual Superannuation Bulletin), starting gross annual income of $62,811 (per ABS Characteristics of Employment – median employee earnings), up to age 26 and 31 respectively. Calculations assume monthly after-tax contributions. Employer contributions are as per legislation and taxed at 15%. Net investment return of 8.37% p.a. is assumed, based on the average annual 5-year performance of growth investment options available for a 21-year-old (Canstar’s database; returns effective to 31 Mar 2022). Average life and TPD insurance premiums of $195.69, are charged at the end of each year. ASX 200 ETF based on the net total return of the S&P/ASX 200 Index over the past 5 and 10 years (effective to 16 June 2022). Calculations include the average account keeping fee and brokerage of a selection of micro-investing platforms, with the account keeping fee charged every 30 days. Assume contributions every 30 days. Other taxes, transaction costs or account fees may apply. Actual returns and fees will vary by investment product. The value of your investment will rise and fall over time. Past performance is not a reliable indicator of future performance. Savings account earnings are based on the current highest savings rate for a 21-year-old in Canstar’s database at 3.00%. This table assumes deposits are made monthly for after-tax Super contributions, savings and ETF investments and any accounting keeping fees are charged every 30 days. The 5 and 10 year total net return are 6.74% and 8.71%.

What to consider when choosing your savings option

When it comes to picking which savings vehicle is right for you, it’s important to weigh up how long you plan to invest for and how you feel about risk.

If you’re saving for a short-term goal, a savings account can be a safe option. The returns may be low, but the value of your savings won’t fall as a result of a market correction.

For longer timeframes, the higher long-term returns of ETFs can turbocharge the value of your savings. The catch is that you won’t always earn ‘average’ returns. Sharemarkets can dish up double-digit gains in some years, and negative returns (losses) in others. This is a risk you need to be prepared to take. Committing to an investment for five years or more can help to smooth out returns on your ETFs.

If you want to top up super, be prepared to not be able to access your money for quite a long time. On the plus side, this could mean you have more money to play with at retirement. And, if you are saving for a first home, tucking cash into super through the FHSS scheme can be an effective way to grow a deposit. That said, the maximum saving of $50,000 through the FHSS scheme means this option will likely only form part, not all, of your total deposit.

The beauty of investing is that you are free to mix and match, potentially using a blend of savings accounts, ETFs and super to achieve different savings goals.

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