Saving for a house in Australia these days is no easy feat. In Perth the median house price is around $500,000 (REIWA 2021) compared with an average household income of $110,084 before tax (ABS 2020). This equates to about 4.5 times the value of a household’s pre-tax salary. Looking at markets like Sydney and Melbourne the situation gets even worse. This difficulty is further compounded by the fact that the interest paid on bank savings accounts are at all-time lows. For example, Commonwealth Bank’s Goal saver account is only paying a maximum of 0.35% p.a. (Commonwealth Bank 2021), at this rate, saving up for a 20% deposit is pretty difficult.
Typical financial advice will say that if you need the money in the short term, then a savings account is your best bet. However, given the current situation with low interest rates I started to wonder if there is a ‘better’ way to save for house than using an old school savings account. Of course, by better I mean faster.
To do this I looked at rolling 5-year periods for portfolios consisting of the MSCI World ex Australia and the All Ordinaries at a 60/40 split between January 1980 and July 2015. The simulation conditions are as follows:
- $1000 will be invested on last day of each month for the required time period.
- A total of $60,000 will be invested
- Each simulated portfolio will start on the last day of each quarter – 31/12, 31/3, 30/6 and 30/9 each year
- The 60/40 combination portfolios will be 60% MSCI World ex Australia and 40% All Ordinaries which approximates our own portfolio construction minus the property fund.
- All distributions are reinvested
This modelling does not take into account:
- Investment or transaction costs
- Taxes on distributions or capital gains
- Currency fluctuation or hedging
Results
The final values and per annum return for each of the 143 simulated portfolios are shown in the 3 graphs below. Additionally, table 1 shows the summary data for the set of simulations.
| Median | $79,846 | 11.37% |
| Mean | $81,919 | 11.18% |
| Std dev | $22,849 | 10.25% |
| Highest | $169,195 | 42.90% |
| Lowest | $47,877 | -8.82% |
Observations
The median return of 11.18% p.a. was quite high, at this level of returns investing $1,000 per month for 5 years (total $60,000 investment) would have grown into $79,846. Further to this, more than 75% of simulated portfolios had a return in excess of 4%, which would have turned a $60,000 investment into around $66,000. 85% of portfolios produced a return greater than 0%.
Increased risk of underperformance
As is very often the case with investing, trying to achieve a higher return comes with an increased risk of underperformance. To provide perspective, if you needed to save a total of $60,000 in 5 years by investing $1000 per month and you chose to use a savings account, there would be close to a 100% chance that you would achieve this goal. The only real risk being that bank interest rates could become negative. When using index funds, this simulation shows that there is an approximately 15% chance that this strategy will under-perform a bank savings account. The worst case being a -8.82% p.a. compounded return which would have resulted in a portfolio value after 5 years of $47,877 (loss of $12,123).
Managing risk
Equities exposure
Risk encompasses the outcome as well as probability so it can be managed by adjusting exposure to one or both of these elements. We can reduce the severity of the outcome by introducing a less volatile asset class to our portfolio. If the above portfolio’s equity exposure is reduced by using 50% cash, we have following composition:
| MSCI World ex Australia | 30% |
| All Ordinaries | 20% |
| Cash | 50% |
Diversifying in this manner reduces the potential downside, and upside of our overall portfolio movements. This means that the worst performing portfolio would provide a return of -4.41% (instead of -8.82%) and a resulting portfolio value of $53,938. Note that this method does not reduce the probability of underperformance, only the value of losses. Also, this strategy will half the upside potential which reduces the median portfolio value to $69,923 from $81,919.
Investment time horizon (period)
Lengthening the investment time period is a risk management strategy that can be used to reduce the probability as well as severity of potential underperformance. In my past simulations, lengthening the investment period reduces spread of returns; and, as a result, the probability of encountering a portfolio with negative returns. For example, over 15-year periods the 60/40 MSCI World Ex Australia/All Ords portfolios the poorest portfolio performance was 1.15%.
Risk free methods
When looking to increase returns, investors should always direct attention towards risk free strategies, in this case taxation and fees. For first home buyers the government is currently running the First Home Super Saver Scheme (FHSS) which allows first home buyers use up to $30,000 of additional contributions to purchase a house. The main benefit of this being that superannuation contributions are only taxed at a rate 15% as opposed to the minimum marginal tax rate of 19% (salaries over $18,201 p.a.) (ATO 2021).
Another item to look at is transaction, administration and funds management fees – these are risk-free ways of boosting returns. If you are using ETF’s then ensure that you are investing enough money each period such that the transaction fees comprise a sufficiently low proportion of your investment costs (I’d aim for around 0.5%). For example, if you are buying $1000 worth of ASX:VAS each month and your brokerage is $20, this represents 2% of the cost. In this case moving to a quarterly investment cycle would drop your brokerage to $20 for $3000 which equates to 0.66%, alternatively, consider using the equivalent managed fund, which is likely to have no transaction costs when using BPay – typically these have higher management expense ratios so do your homework!
Concluding thoughts
Overall, if you are trying to save for a house, or any large purchase that requires a multi-year savings commitment, the mechanism that you choose to use will depend on what level of risk you are willing to take. If you are very rigid with your timeframes and want certainty that you will hit your savings target then using a savings account is the option that will give the highest probability of success.
Having said that, If I wanted to purchase a house within the next 5 years, I would do 3 things:
use a 50/50 cash equities split, similar to what was mentioned above
be flexible with the time frame (give myself up to 7 years)
Set a target to save around 50% of the value of the total purchase price
- use a 50/50 cash equities split, similar to what was mentioned above
- be flexible with the time frame (give myself up to 7 years)
- Set a target to save around 50% of the value of the total purchase price
I estimate that a strategy centered around points 1 and 2 would outperform a savings account approximately 9 times of out of 10. Point 3 is important to me as it would pretty much guarantee that I could make a 20% deposit, but, more importantly, it will give me the cash flow flexibility to continue with the bigger task at hand – building financial freedom.
Engineer your freedom
References
ABS, 2020, Australian household financial resources, Australian Bureau of Statistics, available from: <https://www.abs.gov.au/statistics/economy/finance/household-financial-resources/latest-release>
REWA, 2021, Perth market snapshot, REIWA.com, available from: <https://reiwa.com.au/the-wa-market/perth-metro/>
Commonwealth Bank 2021, GoalSaver, Commonwealth Bank, available from: <https://www.commbank.com.au/banking/goal-saver.html?ei=GoalSav1>
ATO 2021, Individual income tax rates, Australian Taxation Office, available from: <https://www.ato.gov.au/rates/individual-income-tax-rates/>
ATO 2021, First home super saver scheme, Australian Taxation Office, available from: <https://www.ato.gov.au/individuals/super/withdrawing-and-using-your-super/first-home-super-saver-scheme/>