The pandemic has put pressure on many people’s finances. Some are considering whether they can afford to invest for their future, so we thought it was a good time to take a look at savings versus investment.
Financial advisers often say it is prudent to ensure you have at least 3 month’s living costs as savings, separate from your investments. This acts as a personal backstop in case anything goes wrong - for example, a Covid-19 related job loss. However, having all your money in the bank is not going to deliver you a high rate of return and won’t help you in the long term.
The last two years has seen the Official Cash Rate (OCR) drop to record-breaking lows, reaching 0.25% in 2020. While this has picked up to 0.75% over 2021, it still remains low in comparison to pre-pandemic times. The OCR determines the price of borrowing or lending money in New Zealand. It is an interest rate set by the Reserve Bank, which influences all other interest rates, for example, the interest you pay on loans, or the interest the bank pays you for the money you have in your bank account.
What this means is people with money in the bank are getting the lowest interest rates since the 1960s. When combined with inflation currently sitting at 4.9%, well above our 1-3% inflation target this can quickly erode any return that is received.
Technically, money in a bank is still an investment and still comes with a level of risk – you’re investing your money in the bank itself and they are promising to give the money back to you, with a small amount of interest. However, when we refer to investing, we’re generally thinking about investing in non-bank businesses. Over the longer-term, these investments can help you save for your future goals such as buying a house, or planning for retirement.
As we’ve mentioned previously, no investment comes without risk. It’s important to diversify by taking a portfolio approach to your investment strategy, and also to ensure you do due diligence on any companies you invest in. Generally you will be rewarded with a risk premium (or bigger increase in value) for risk you take. Over the long term, the higher the risk, the higher the reward (on average) but what you should invest in does depend on your appetite for risk.
Over time, small differences in returns can build up to make a significant difference to your overall wealth. So after you have your personal backstop savings sorted, even if you only have small amounts to invest, consider a diversified investment portfolio, rather than just putting the extra in the bank.
The important role of private investment in economic growth is another reason why you might choose additional investment over additional savings. Consider how you can both be rewarded for your investment activity, and make a positive impact on the companies you support. Although banks certainly do have an important role to play in the New Zealand’s economy, putting more money in the bank will do little to stimulate our economy, unlike investing in carefully selected New Zealand businesses. Just make sure you have 3 month’s living costs saved first, and follow a diversified approach that keeps your risk within your own risk appetite.
By Michelle Polglase