Noel Whittaker's Blog I wrote recently about withdrawing money from your superannuation under the emergency regulations, and pointed out that it should only be done as a last resort. This was because of the compounding effect on a sum like $20,000 over 30 years.
But this week a reader questioned the logic. He said “if the choice is to spend $20,000 today, or $50,000 in 37 years time, surely there is no difference because of the loss in value of money over time.” He figured the sums were the same in today’s dollars so you may as well enjoy spending the $20,000 today.
It raises the question of the depreciating value of money due to inflation. Let’s assume that inflation runs at 2% over the next 37 years. If that’s correct $10 today would be worth $21 in 37 years. To put it simply, the purchasing power of your money would halve in 37 years if inflation runs at 2% per annum.
So our reader is not too far off when he says the $20,000 today is almost equivalent to $50,000 in 37 years. However, it would be a very bad investment that produced a return equal to inflation. In fact, most superannuation funds aim at inflation plus six percent over the long haul.
By changing the expected rate of return from 2% per annum to 8% per annum, and using the Compound Interest Calculator on my website www.noelwhittaker.com.au we find that $20,000 invested today becomes $345,000 in 37 years.
This is a graphic illustration of the way the rate of return affects the outcome of your investment strategy, and a warning to all of us to examine our superannuation in detail to make sure the money is invested in an asset allocation that fits your goals and your risk profile.
Also be aware of the importance of time. If your fund is earning 8% per annum it is doubling every nine years. In the example above the $20,000 was worth $40,000 after nine years, $80,000 after 18 years and $160,000 after 27 years – every time your money doubles there is more growth in the last double than in all the previous doubles. This is the power of compounding.