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The case for investing over fixed deposits

Given the risks involved in buying shares, why do so many people opt for shares over fixed deposits at a bank? Sure the returns are lower but they are miles safer. I guess what I want is for you to build a safe and sensible case for being a share player. I am 23 years of age and have recently been left $30,000 by a relation as an inheritance.

It’s a good question and so let me actually look at your amount of money – $30,000 – and see what would happen to it over, say, 42 years of investment. I will use the rule of 72 to work out prospective returns and then build a case for shares.

By this rule, if you were lucky enough to average six per cent on your fixed deposit at a bank over 40 years, your $30,000 could end up as going to $60,000 after 12 years, $120,000 by the 24-year mark, $240,000 at the 36-year mark and around $400,000 after 40 years.

By taking six per cent and dividing it into 72 you get the number 12 and that means your money doubles every 12 years. However, there is tax on bank deposit interest so six per cent might end up being four per cent and so your money doubles every 18 years!

And this builds the case for shares, despite the fact that they are more risky. Now I know some people will argue with this, but good quality dividend-paying shares have a history of paying 10 per cent out of the dividends and the capital gain. So, after tax, if we say eight per cent is the return then your money doubles every nine years! That means your $30,000 could, and I say ‘could’, go double almost four-and-a-half times with shares – that’s $60,000 to $120,000 to $240,000 to $480,000 and, ultimately, about $700,000.

On the other hand, your bank deposit goes from $30,000 to $60,000 after 18 years, then to $120,000 after 36 years, and wind up around only $140,000 after 40 years. These are just rough approximations but it builds the case why people accept the riskiness of shares over the safeness of deposits. The latter will give you less anxiety, and while the former will make your wealth ride a rollercoaster, if you select great companies you can reduce the risk and capture pretty good returns.

By the way, you could put $10,000 in a deposit, which you roll over and over while the other $20,000 could be in shares, which gives you a bit of balance between risk and safety.

Also with shares you can borrow to create tax deductions which can mean the taxman helps you build up your wealth. This comes with more risk but lots of people have used this strategy to turbo charge their wealth building efforts.

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Saturday, April 16, 2011

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