am i in the right kiwisaver scheme? It s Your Future

Transcription

1 am i in the right kiwisaver scheme? It s Your Future

2 Am I in the right KiwiSaver Scheme? page introduction 3 income and default schemes 4 growth schemes 7 nz funds lifecycle process -the best of both worlds 9 summary 10 appendices 11 further information is contained in the investment statement for the nz funds kiwisaver scheme. a copy may be downloaded from our website

3 nz funds kiwisaver scheme : : am i in the right kiwisaver scheme? 3 Introduction a recent investment industry study completed in the united states found that 58 percent of employees spent less than one hour determining both their retirement plan (for new zealand read kiwisaver) savings contribution rate and which retirement plan investment scheme to use 1. Since the advent of KiwiSaver five years ago, New Zealanders have much to be proud of; over 1.9 million people 2 have enrolled, accumulating $12 billion in member balances. By 2022 it is estimated that kiwisaver member balances will have snowballed to over $60 billion. Thanks to the Government s $1,000 kick-start payment, opting in to KiwiSaver was the easy part. A much harder decision is selecting the KiwiSaver scheme which is right for you. And by spending less time considering a 10 or even 40-year investment than we do selecting a television set, many New Zealanders risk accumulating half as much capital as they could have. This booklet provides an overview of the two broad scheme types available to KiwiSaver members: income or default schemes, and contrasts them with growth schemes, and NZ Funds Management s LifeCycle approach (which simply means a combination of income, inflation and growth assets that change based on your age). If you, or someone you know, are invested in KiwiSaver, the following overview may have a significant impact on your future wealth. 1 Iyengar, Huberman and Jiang (2004). 2

4 nz funds kiwisaver scheme : : am i in the right kiwisaver scheme? Income & Default schemes an estimated 36% of kiwisaver members 3 are invested in default kiwisaver funds selected either by their employer or through the default fund allocation process. it was an excellent decision for kiwisaver to auto enrol new employees not already in a scheme and to have pre-selected default kiwisaver fund options for new kiwisaver members. By requiring new employees to opt out of KiwiSaver, more New Zealanders have enrolled in KiwiSaver than if they had been asked to opt in. Similarly, to get more New Zealanders to participate in an automatic savings programme, it was important to make the initial choice whether to be in or not and what fund to be in as easy as possible. If employees had been required to initially choose their KiwiSaver investment manager, international experience shows far fewer New Zealanders would currently be enrolled. Default KiwiSaver funds were an easy and relatively lower risk way to get started for many KiwiSaver members. By law, default KiwiSaver funds are required to have between 75% and 85% of their funds in income assets. There is however a downside to requiring default KiwiSaver funds to primarily invest in cash and income assets. Even if all goes well, many KiwiSaver members in default KiwiSaver funds may accumulate significantly 3

5 5 less over the long-term than we believe they ought to have. If things go badly, they stand to lose a significant amount of wealth. The majority of us understand that historically over long periods of time, shares outperform cash and bonds but shares are riskier. Unfortunately, many New Zealanders appear not to understand that the longer they invest the smaller the risk of loss with a well diversified portfolio of shares. Conversely there is a greater risk of loss, in real terms, by holding a significant portion of their retirement wealth in cash and income assets, where real terms means after the effect of inflation. How can cash and income assets destroy wealth? Simply put, if the price of the goods which we wish to purchase in retirement rise faster than the value of our investment, we will be worse off. If this occurs for an extended period of time, as occurred in New Zealand from 1970 to 1986, we may find ourselves materially worse off. NEW ZEALAND S ACTUAL INFLATION EXPERIENCE: 1970 TO 1980 RETURN PER ANNUM 14% 12% $100 10% 8% 6% 4% $56 $46 2% 0% INFLATION SIX MONTH DEPOSIT RETURN DEPOSIT RETURN AFTER 28% TAX source: bloomberg, a tax rate or 28% was assumed as it is indicative of the highest pie tax rate from 1 october From 1970 to 1986, the price of goods (inflation) rose by 12.5% pa 4. Over the same period of time an investment in term deposits returned 9.5% pa 5, thereby not even keeping pace with the inflation rate. In addition, this return does not factor in the requirement to pay income tax on your returns. Assuming a PIE tax rate of 28% over this period, the return from term deposits would have fallen behind inflation by 5.5% pa. 4 Statistics New Zealand. 5 Reserve Bank of New Zealand.

6 nz funds kiwisaver scheme : : am i in the right kiwisaver scheme? The inflation rate need not be high for this to occur. Over the last three years inflation in New Zealand has been only 2.6% pa. During that time interest rates, as measured by the Reserve Bank of New Zealand s Official Cash Rate, have averaged the same, 2.6% pa. Unfortunately, after tax, investors have lost a small portion of their purchasing power for every year they were invested in cash. It will make little difference to most New Zealanders wealth if, over the short to medium-term, the after-tax returns from their cash and income assets lag inflation. Cash, income (and inflation orientated assets) are therefore ideal asset classes to use when investors have a timeframe of less than ten years. Similarly, as many New Zealanders had never accumulated wealth by saving into a professionally managed portfolio, ensuring that the default KiwiSaver fund option was easy to understand meant many more chose to invest than not. However, today more education is needed to explain the considerable downside associated with investing in cash and income for extended periods of time. as an interesting side note, there are currently six default providers registered in new zealand, of which four are owned by large australian based banking or insurance conglomerates and one is owned by a large united states organisation. while there has been considerable debate about the merit of privatising $6 billion of stateowned assets, there has scarcely been a murmur about our collective decision to invest the majority of new zealanders kiwisaver savings (an estimated $60 billion over the next 10 years) with australian owned conglomerates. so what are the alternatives?

7 7 Growth Schemes as shares have historically outperformed all other asset classes over extended periods of time, it makes a lot of sense to choose a kiwisaver scheme which has at least some allocation to shares. since 1871 the united states share market (the largest in the world) has averaged a 9% pa return 6. over long periods of time these kinds of growth rates can snowball $10,000 into $122,677 after thirty years, and that is before thirty years of regular contributions. Shares represent nothing more (or less) than the proportional ownership of a business which in a public form collectively make up a major portion of the global economy. As the global economy has grown for centuries, so too has the value represented by publicly listed companies (the share market). And while an individual company s fortunes are extremely uncertain, these can be mitigated by the ownership of the wider share market through index portfolios which are made up of the shares of thousands of companies. When old companies fail, new ones take their place. As part owners of these companies, investors are entitled to the increase in business value and a share of annual income. However, as with cash and income investments, shares too come with a downside. The cyclical nature of economic growth means that for significant periods of time a well diversified portfolio of shares made up of the major share indices around the world can

8 nz funds kiwisaver scheme : : am i in the right kiwisaver scheme? be worth less than investors originally paid. And while shares historically outperform cash over the long-term, investors may require their capital at a specific point in time, for example when they find the right house for a first home purchase, or when they choose to retire. If the global economy is weak at that point in time, investors may end up withdrawing considerably less than if they had kept their retirement savings in cash. This is exactly what happened in the United States following the introduction of 401K (the United States equivalent of KiwiSaver) in the late 1970s. Many Americans invested their 401K scheme in growth assets which predominately invest in the United States share market. From 1980 to 2007 the United States share market rose 10 fold (S&P500), resulting in an average retirement plan balance of over $70,000 for all 401k scheme participants (including new entrants) by However, as they approached retirement few 401K members chose to rebalance; the returns were too good! And in 2008 the United States share market declined by 38.5% wiping out just under half of the retiring generation s life savings. Investing in growth assets, like shares, has over time helped investors accumulate significantly more wealth than they would have otherwise done. However, the best outcomes occur when those growth investors plan their exit from the share market well in advance. Years before retirement, investors need to begin modifying their asset allocation away from shares and into investments which are more stable over the short to medium-term like cash, income and inflation orientated assets. The idea that a single growth orientated KiwiSaver Scheme is equally suitable for a 20 year old as it is for a 60 year old contrasts sharply with the experiences of the United States retirement industry.

9 9 NZ Funds LifeCycle Process: The best of both worlds the nz funds kiwisaver scheme (scheme) is designed to provide new zealanders with the best of both worlds. from the outset scheme members are exposed to three portfolios: income strategy; inflation strategy; and growth strategy. this enables the scheme members to be well diversified and to seamlessly reduce their exposure to growth assets as they get closer to retirement. Under the MemberChoice option, members may select their own mix of the three portfolios, while under the LifeCycle option, the Scheme calculates the number of years that each member has until they reach the withdrawal age of 65 and customises their allocation to the Income, Inflation and Growth Strategies accordingly. In this way, members below the age of 45 who have at least 20 more years to invest before the withdrawal date have a high exposure to growth assets. From age 46 onwards their growth exposure is gradually reduced and their exposure to income and inflation strategies is increased in preparation for the withdrawal date. While there are other KiwiSaver Schemes which offer reduced risk in the lead up to retirement, to date the NZ Funds KiwiSaver Scheme is the only scheme to annually revisit and reallocate each member s asset allocation based on their age. NZ FUNDS KIWISAVER SCHEME LIFECYCLE PORTFOLIO MANAGEMENT PROCESS 100% growth strategy inflation strategy income strategy 80% 60% 40% 20% 0% source: nz funds management member s age

10 nz funds kiwisaver scheme : : am i in the right kiwisaver scheme? Summary now that we as a nation have successfully embraced kiwisaver, it is important that new zealanders ensure the assets they hold match their investment risk profile and time horizon. unfortunately, this appears a more difficult decision than the initial opt-in or opt-out decision. As a consequence many New Zealanders have not yet actively selected a KiwiSaver scheme to invest with and currently invest in a default KiwiSaver fund. Over time, as public awareness (and KiwiSaver balances) grows, we expect more New Zealanders will consider their options carefully. The NZ Funds KiwiSaver Scheme, and in particular the LifeCycle portfolio management process, was designed to ensure New Zealanders hold the right mix of investments for their age and stage. Over any given decade such an approach is unlikely to produce outcomes at the top of performance tables, but neither should it produce outcomes at the bottom. It s Your Future

11 Appendices LIFECYCLE APPROACH: STRONG AND WEAK MARKET COMPARISON strong share market returns (1991 to 2001) $3,500 $3,000 income strategy growth strategy lifecycle process $2,943 $2,500 $2,440 $2,000 $1,959 $1,500 $1,000 $ member s age weak share market returns (2001 to 2011) $3,500 $3,000 income strategy growth strategy lifecycle process $2,500 $2,000 $1,500 $1,494 $1,000 $1,084 $824 $ member s age source: msci world index in local currency, anz government bond index. If you would like to learn more about the NZ Funds KiwiSaver Scheme and the LifeCycle process please contact your financial adviser or visit our website at:

12 new zealand funds management limited level 16, zurich house, 21 queen street, private bag 92163, auckland phone freephone kiwisaver@nzfunds.co.nz website -