It’s generally accepted that one of the most important decisions you can make about your KiwiSaver account, or any long term savings plan for that matter, is how your money is invested. The mix of cash, fixed interest, property, infrastructure and shares has a direct influence on the risk and reward you’re likely to experience in years ahead, and of course, your retirement pot.
This mix of investments should align with your investing horizon, appetite for ups and downs along the way and your goals. Sounds logical but from our own experience we know many members are not in the most appropriate fund for them. Typically, KiwiSaver members are invested too conservatively which means they are potentially missing out on thousands of dollars in retirement.
There can be many reasons for this. Some people are naturally risk averse so err on the side of caution. For people who have never invested before, choosing a fund is something they’ve never had to do before so it may be daunting. There’s also another group of people who have simply been defaulted into KiwiSaver (their money is regulated to be invested conservatively) and not actively sought out the most appropriate fund for them.
So what’s the cost of being invested too conservatively? Quite simply, a lot. And this is particularly evident over the longer term.
Over the long term, the power of compounding returns really works for you. This is where you not only earn money on what you have saved but also on your investment earnings along the way. Even a small increase in the average annual return on your savings makes a significant difference to the value of those savings when you retire.
In the following example, employee, employer and government contributions are the same but the annual difference in return is 2%. Now, over one year 2% may not sound like a lot or worth worrying about but it’s over the long term through the power of compounding returns that 2% turns into some serious moolah; in this case more than $100K. $100K goes a long way and can make a big difference to your retirement plans.
Of course, it’s important you are comfortable taking on some extra risk in order to be rewarded with higher returns. The longer your investment timeframe, the more you may be comfortable with an investment strategy that consists of more growth assets, such as shares. We think growth assets are important, as most KiwiSaver members have a long time to save for their retirement. Historically, investing in growth assets has produced better long term returns than investing in other asset classes, minimising the impact of inflation over time on your savings.
However, if you are nearing retirement or saving for a first home, you may want to have a more conservative investment approach. Income assets such as cash and fixed interest typically produce more stable returns in the short term.
Results are simulated in this chart. This analysis assumes an investor starts saving on 1 June 2016 at age 23 with an annual salary of $35,000. Their salary rises steadily at 3.5%pa until at age 65 they retire. Of this salary they contribute an after-tax 3% to their KiwiSaver scheme and their employer contributes a before-tax 3%. The employer’s contributions remain subject to contribution tax at current rates (see ). KiwiSaver Member Tax Credits of $521.43 per year are received throughout each period. No withdrawals are made.
Two investment return assumptions are presented. One is an assumed return of 4% after tax and fees each year. The other is an assumed return of an additional 2%, making a total return of 6% after tax and fees each year. All portfolio amounts are shown in today’s dollar terms.
By presenting portfolio amounts in today’s dollar terms, we have stripped out the impact of inflation from the results, so as to compare purchasing power at retirement with today’s prices for goods and services. Inflation is assumed to average 2%.