One of the toughest tests in parenting starts with the playground.
Just how far to you encourage your children to take risks and how much freedom do you given them to learn valuable lessons through trial and error and potentially bruises and scrapes along the way?
While it might come some years later, there is also a similar conundrum in teaching older children how to handle the financial playground and what their attitude should be to risk versus reward with money.
The Million Dollar Difference
This is arguably an even more important playground to master because it can literally make a million dollar difference or more to their financial future.
Attitudes to money start to develop early as children learn the difference between saving and spending and the benefits of delayed gratification.
Some long-term studies have even shown that children who understand delayed versus instant gratification early do much better with money in the long term as well.
One of the earliest – and most significant – financial choices now comes with the first job and the choice of how to invest the child’s superannuation.
With a really long time-frame ahead of them before they will ever get to enjoy this money, it is one of the best and most important examples of delayed gratification there is.
Long Term Trends Hard to Beat
While nobody can forecast future returns with too much precision, over such long periods of time the benefits of increasing the risk profile are startlingly apparent.
Simply ticking the high growth or growth options when choosing the initial superannuation fund investment instruction rather than the usual default balanced option is likely to make a million dollar difference in the eventual retirement balance.
That is the sort of delayed gratification difference that could excite anybody and keep them on the long path to a successful retirement even if they can barely envisage it now.
Investment is the ultimate playground in which more risk is rewarded and over a lifetime the odd loss when markets have a bad year will be more offset by the great years when the super fund will perform better than the average fund.
Avoiding Balanced Asset Allocations
Under the usual asset allocations a “balanced” investment option will be 50 to 70% invested in growth assets, like shares and property, with the balance in defensive assets like bonds and cash.
While a balanced fund will deliver a smoother return with lower peaks and smaller dips, the cost of that ride is demonstrably lower returns.
In the very long term that is a really terrible trade off, although it may have its uses during the early retirement period when sequencing risk is particularly high.
By encouraging young people to tick the growth or high growth option, they are virtually guaranteed more money at the other end.
Differences Over Twenty Years
Take the past 20 years, for example.
Australian shares have returned 8.1% a year over that time, international shares have returned 9.3% and Australian bonds have returned just 4.2%.
In an environment in which every basis point counts for really big bucks in cumulative returns, that can easily transform ticking the growth or high growth box into an extra million dollars of retirement balance or more.
It is common sense really – for someone in their twenties, it makes no sense to have much money in cash or defensive assets.
It will be 40 years or more before they need access to any cash so that lump of conservatively invested cash is just holding back returns.
While that might smooth the graph a little, in a very short time the growth or high growth selection will diverge from the balanced return and leave it far behind.
There may be some years in which the balanced portfolio outperforms the growth or high growth fund but they will be few and far between and totally overwhelmed by the many years when the outperformance will be bigger and in the other direction.
Extra 1.5% Makes a Massive Difference
Using the average industry balanced fund return over the past 10 years of about 8.1%, a $20,000 super balance will grow to be $657,120 in 45 years.
That’s not bad but if it was instead invested at the average 10-year growth fund return of 9.6%, it will be $1,058,109.
That’s a very tempting difference and shows that an extra 1.5% a year results in a 61% higher balance.
However, that is only half of the story.
Compounding Contributions Significant
If we include continuing super contributions over a working life, the magic of compounding creates an even better picture.
Using an assumption of a starting salary of $80,000 a year that goes up by 2% a year and a retirement at age 67 with employer contributions of 12% of salary, then under the balanced option the final sum would be $3.783 million in super.
Using the same assumptions under the growth option, the final sum would be $5.581m.
An extra amount of almost $1.8m, or 48% more – that’s a really convincing example of delayed gratification and controlled risk producing an exceptional result.
