Understanding real returns
Tax advantages and the impact of inflation means that super can give you a lot more bang for your buck when it comes to real return.
This example compares the ‘real’ return of two investments worth $100; an investment outside super and the return on an investment in super.
| Investment outside super |
|
Investment inside super |
| $6.00 |
|
$6.00 |
| $4.20 |
|
$5.10 |
| ($3.50) |
|
($3.50) |
| $0.70 |
|
$1.60 |
This example tells us that when you account for tax and inflation, an investment inside super means that you can more than double your real return. The higher return also means you have a greater chance of keeping pace with inflation over the long term.
The example assumes that you pay 30% income tax; if your income is taxed at a higher rate the real return of an investment in super will be even higher when compared to an investment outside of super.
Why is inflation relevant?
Inflation is the concept that a dollar will buy you less tomorrow than it does today. For example, a loaf of bread today costs $3.50 (give or take). In 1970, a loaf of bread cost 28 cents. What seems like a lot of money today will only be worth a fraction of that amount in the future- because of the impact of inflation on the purchasing power of a dollar.
The same principle applies to Cash investments. Over the long-term, they have historically earned a lesser rate of return than growth type investments in shares and property. There is also an increased potential for inflation to erode the buying power of your money if Cash returns don’t outperform inflation.
Tax matters
All investments are taxed. Generally, we pay tax on investment earnings at our marginal tax rate. This is usually 30% (or 31.5% with Medicare levy) for most people. For an investment in super, you pay a discounted tax rate of 15% on investment earnings; that’s 15% less tax than the marginal tax rate paid by most people.
Lower taxes mean that your real rate of return is much higher inside super than outside. Inside super, your investment will also benefit more from the effect of compound interest; you earn extra interest on your extra interest and so on, not just on your original investment amount.