Lesson type: Think like an investor

A lesson from the Budget: Save frequently, start now

The tax cuts unveiled in the 2018 Budget don’t on their own look like much. Ten dollars is a decent (if not the healthiest) feed at McDonalds – the apocryphal “burger and a milkshake” – but it’ll buy you only half a kilo of macro organic lean beef mince axt Woolies, which is barely enough for a decent spag bol (and let’s not get started on the cost of the red wine you will need).

Under the measures announced by the Treasurer Scott Morrison on May 8, someone earning $37,000 a year will receive $530 a year via a tax offset (which essentially means you claim it back in your tax return). The offset reduces as your income rises, until it vanishes when you’re earning $48,000 a year.

But ten bucks is not nothing, and if you can couple the discipline of regular saving with the power of compound interest you can quite quickly generate fairly tidy sums of money.

It’s arguable whether it was really Albert Einstein who described compound interest as the eighth wonder of the world; but whoever it was, they had a good reason to call it that. It really is the investor’s best friend – interest paid on interest paid on interest over a long period of time leads to exponential growth in savings, and is about the closest thing you’ll ever get to a free lunch.

But the other powerful ally all successful savers have is simple discipline: commit and stick to a plan to save regularly. Over the long term it matters how often you save, as well as how much you save.

Almost every bank, mortgage provider and super fund offers an online savings calculator, so No More Practice ran the numbers through a randomly selected one to see what came out at the other end. Each time, we assumed we started out with no savings, and we assumed we’d earn an interest rate of 2.5 per cent a year. You have to admire our optimism.

The maximum tax offset of $530 a year works out at about 10.20 a week. It also therefore works out at $44.16 each calendar month. And it matters whether you save weekly, yearly or monthly.

If you bang $530 into a bank account in one go, at the end of the year when you get the offset paid to you, then obviously you’ll only have $530 at the end of the year.

But if you can put $44.16 a month into the same account then by year’s end you’ll have $534.

And if you save $10 a week, every week, for a year, you’ll end up with $536 at the end of the year. It’s only a few dollars, but hey, it’s free money.

And the gap widens, of course, the longer you save for. If you put $10 a week into an account every week for five years, you’ll end up with $2824. .

If you put $44.16 a month into an account every month for five years, you’ll end up with $2819.

And if you put $530 into an account once every year for five years you end up with $2785. The eagle-eyed will have spotted that in each case you have contributed exactly the same amount to your account – that is, $2650 – but the frequency of the saving, linked to the power of compound interest, leads to the different end values, with no additional effort of commitment on your part.

The basic lesson from all of this is simple. It doesn’t matter how much or how little you are able to save, the key is to save regularly, and start ASAP. It pays to shop around for the best interest rate on your savings, as well, but that’s a story for another time.

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