Download the case study 151.56 Kb

SUPERANNUATION – Different Drivers at Different Stages

Accumulating sufficient super to fund your retirement, is a challenge facing us all.

However, a range of factors interact to produce the final outcome and a better understanding of how these different factors work, can make for better planning and better outcomes.

Factors

After fees and taxes, 3 factors determine the final result. They are :

1. Contributions
2. Earnings
3. Time

Contributions is an obvious one. The more you contribute, the more you will have at the end (other things being equal).

However, other things often are not equal and this is where it starts to get interesting.

The effect of time is very important. It is over time that the importance of earnings grows, especially the effect of compound earnings.

Compound earnings means "earnings on earnings" and over extended periods, it is very powerful.

To get the idea, look at an example. Say you start with $10,000 and it earns 10% (to make the maths easier). At the end of the first year, you will have $1,000 of earnings.

If you reinvest the $1,000 and it earns 10% again, then in the second year you will earn $1,100 (compared with only $1,000 if you spent the first year's instead of reinvesting it).

Over the longer term, the importance of compound earnings grows and grows and small differences in earnings can make big differences to the end result. Also, if your fund has been running for many years, the amount that accumulates will contain much more that is "earnings" than "contributions".

The following table illustrates these points. To keep it simple, I have assumed contributions of a steady amount of $10,000 p.a. at two earning rates – 7% pa and 9% pa.

Note:

I. The above table is based on contributions of $10,000 p.a. net of contributions tax.  Returns are net of investment tax.

II. In the early years, the biggest driver is contributions. In later years, earnings become more important.

III. Extending point (ii) above, in year 21 the earnings would be $29,701 at 7% or $48,116 at 9% - which makes the contributions ($10,000) pale by comparison.

iv. Future returns cannot be guaranteed and are purely illustrative.

Amount

As the account balance grows, the main drivers of account growth changes. Initially, when the balance is low, the main driver is contributions. For example, if the account balance at the start of the year is $15,000 and a further $15,000 is added then the balance is $30,000.

If earnings are 10%, then the balance at the end of the year will be $33,000.

The total has grown by $18,000 - $15,000 from contributions and $3,000 from earnings.

Now let's look at another example.

Suppose the balance at the start of the year is $300,000 and a further $15,000 is added (total $315,000). If it then earns 10%, the earnings for the year will be $31,500 – which is over twice the amount contributed.

As the account balance grows, the more important earnings will become and the less important (relatively) contributions will be. Hence, as the account balance grows, it makes sense to pay increasing attention to investments in your fund and their performance.

Life Stages

In reality, things are rarely as simple as the above example shows. As we move through life, most of us go through different stages, with differing expenses and different needs. At different stages, the priorities may shift between debt repayment (e.g. pay the mortgage); family protection (e.g. young children, big mortgage, therefore need good insurance cover), wealth accumulation for retirement and finally retirement income.

Any well thought out plan should take these changing circumstances into account and also bear in mind the factors outlined above.

 Download the case study 151.56 Kb