Which Kiwisaver Scheme Is Right for You?

Which KiwiSaver Scheme is right for you?

Prepared by New Zealand Funds Management Limited Am I in the right Income and KiwiSaver Scheme? default schemes

Introduction Why default schemes are a great start

We all enjoy a holiday and by making good financial An estimated 13.6% of KiwiSaver members2 are decisions today our retirement can be just as invested in default KiwiSaver schemes selected either enjoyable. by their employer or through the default fund allocation process. It was an excellent decision for KiwiSaver to However, an investment industry study completed auto enrol new employees not already in a scheme and in the United States found that 58% of employees to have pre-selected default KiwiSaver scheme options spent less than one hour determining their for new KiwiSaver members. retirement plan savings rate and which retirement plan investment scheme to use1. By requiring new employees to opt out of KiwiSaver, more New Zealanders have enrolled in KiwiSaver than By reading this booklet we can help you avoid if they had been asked to opt in. Similarly, to get more making many of the mistakes others have made in New Zealanders to participate in an automatic savings preparing for retirement. programme, it was important to make the initial choice – whether to be in or not and what scheme to be in – as Being enrolled (and involved) matters easy as possible. If employees had been required to Since the advent of KiwiSaver in 2007, New initially choose their KiwiSaver provider, international Zealanders have much to be proud of; over 2.9 experience shows far fewer New Zealanders would million people2 have enrolled, accumulating $57 currently be enrolled. 2 billion in member balances. Default KiwiSaver schemes were an easy and Opting in to KiwiSaver is the easy part. A much relatively lower risk way to get started for many harder decision is selecting which KiwiSaver KiwiSaver members. By law, default KiwiSaver scheme is right for you. And by spending less time schemes are required to have at least 75% of their considering a 10 or even 40-year investment than funds in income assets. There is however a downside we do selecting a television, many New Zealanders to requiring default KiwiSaver schemes to primarily risk accumulating half as much capital as they invest in cash and income assets. Even if all goes could have. well, many KiwiSaver members in default KiwiSaver schemes may accumulate significantly less over the This booklet provides an overview of the two long term than they might have, and if things go badly, broad scheme types available to KiwiSaver they could potentially lose a significant amount of members: income or default schemes, and wealth in real terms. contrasts them with growth schemes, and NZ Funds’ LifeCycle approach.

1. Iyengar, Huberman and Jiang (2004) 2. FMA KiwiSaver Annual report, June 2019

2 How inflation can hurt income and default schemes

As you may know, over long periods of time shares annum. During that time interest rates, as measured by have historically outperformed cash and bonds the Reserve Bank of New Zealand’s Official Cash Rate, but shares have also been ‘riskier’. However, the also averaged 2.6% per annum. After tax, investors longer you invest in shares (via a well diversified lost a small portion of their purchasing power for every and well managed portfolio) the smaller the risk of a year they ‘invested’ in cash. A further example using six permanent loss of capital. month term deposits is provided on the next page.

Unfortunately, fewer New Zealanders understand that Cash and income assets can be ideal asset classes to there is also a risk associated with owning cash and use when investors have a timeframe of less than 10 bonds, the two types of assets predominately used in years. This is because over the short to medium term it conservative or default style KiwiSaver Schemes. This makes little difference to most New Zealanders’ wealth is the risk that your investment fails to grow over time, if their after-tax and after-inflation returns are low. or actually declines in ‘real terms’. Further, as many New Zealanders had never How could cash and income assets destroy wealth? accumulated wealth by saving into a professionally Simply put, if the price of goods and services (inflation) managed portfolio before, ensuring that the default rises faster than the value of your savings, you will be KiwiSaver scheme option was easy to understand and worse off in retirement. If huge inflation rates occur for relatively stable, meant many more chose to invest an extended period of time, as occurred in New Zealand than not. However, today more education is needed to from 1970 to 1990, you may find yourself materially explain the opportunity cost associated with investing worse off. in cash and income for extended periods of time.

Thankfully bouts of high inflation are increasingly So what are the alternatives? rare. Yet the rate of inflation need not be high for it to erode much of the return generated by a conservative or default style Scheme. For example from 2009 to 2011, inflation in New Zealand was only 2.6% per

“Today more education is needed to explain the opportunity cost 3 associated with investing in cash and income for extended periods of time.”

nz funds : : which kiwisaver scheme is right for you? : : november 209 3 New Zealanders’ return experience - 12 months to 31 March 2019: Six-month deposit return (at April 2018/October 2018)

Six month deposit 3.27% Assumed Prescribed Investor Rate (PIR) Return per annum (0.92%) Cost per annum Inflation rate (1.50%) Rises in prices per annum

Increase in wealth 0.85% Return per annum

Source: RBNZ and NZ CPI. A tax rate of 28% was assumed as it is indicative of the highest PIR.

Case study: Adjusting income returns for inflation and tax For the 12 months ended 31 March 2019, six month term deposits returned 3.27% per annum. However, over the same period of time the price of goods (inflation) rose by 1.50% per annum. For those investors with a PIR of 28% their after-inflation and after-tax rate of return was only 0.85% per annum. A lot less than expected!

4 nz funds : : which kiwisaver scheme is right for you? : : november 209 Growth schemes

As shares have historically Shares represent nothing more (or less) than the proportional ownership of a business which in a public outperformed most other asset form collectively make up a major portion of the classes over extended periods of time, global economy. it makes a lot of sense to choose a As the global economy has grown for centuries, so too KiwiSaver scheme which has at least has the value represented by publicly listed companies (the share market). And while an individual company’s some allocation to shares. Since 1871 fortunes are extremely uncertain, that can be mitigated the United States share market (the by ownership of the wider share market which is made largest in the world) has averaged up of thousands of companies. When old companies fail, new ones take their place. As part owners of these 3 9% per annum . Over long periods of companies, investors are entitled to the increase in time that kind of growth rate can business value and a share of annual income. However, as with cash and income investments, shares also come snowball $10,000 into $122,677 over with a downside. 30 years, and that is before 30 years The cyclical nature of economic growth means that for of regular contributions! significant periods of time a well diversified portfolio of shares can 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.

3. Professor Robert J. Shiller, Yale University to the year ended 2012.

5 “The idea that a single growth oriented 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 and common sense.”

This is exactly what happened in the United States Investing in growth assets has helped investors following the introduction of 401K (the United States accumulate significantly more wealth than they would equivalent of KiwiSaver) in the late 1970s. Many otherwise have done. However, the best outcomes Americans invested their 401K scheme in growth occur when those growth investors plan their exit assets, like shares, which predominately invest in the from the share market well in advance. Years before United States share market. From 1980 to 2007 retirement, investors need to begin modifying the United States share market (S&P500) rose 10 their asset allocation away from shares and into fold, resulting in an average retirement plan balance investments which are more stable over the short to of over $70,000 for all 401K scheme participants medium-term like cash, income and inflation oriented (including new entrants) by 20074. assets – see the graphs on page 10. The idea that a single growth oriented KiwiSaver scheme is equally However, as they approached retirement few 401K suitable for a 20 year old as it is for a 60 year old members chose to reduce their exposure to shares; contrasts sharply with the experiences of the United the returns were too good! And in 2008 the United States retirement industry and common sense. States share market declined by 38.5% wiping out just under half of the retiring generation’s life savings.

4. Fidelity Investments

6 nz funds : : which kiwisaver scheme is right for you? : : november 209 Make your money work harder – Actual investment returns 2002 to 2017

$455,000 $785,000

Source: NZ Funds calculations, 28 May 2019. Returns: Income Strategy and Growth Strategy from NZ Funds Wealth Technologies average market experience (2002-2017), after tax and total annual fund charges. Calculation details are available on request.

What about the downside?

TECH CRASH GLOBAL FINANCIAL CRISIS (APR 2000 - MAR 2003) (NOV 2007 - FEB 2009)

20+ YEARS* 20+ YEARS* % % 45 TO RECOVER 51 TO RECOVER IN CASH IN CASH

4.2 YEARS 3 YEARS TO RECOVER TO RECOVER IN SHARES IN SHARES

Source: NZ Funds calculations. Dated 28 May 2019. * RBNZ six-month term deposit rate, 30 April 2019, 3.26% before tax.

nz funds : : which kiwisaver scheme is right for you? : : november 209 7 NZ Funds’ LifeCycle: The best of both worlds

The NZ Funds KiwiSaver Scheme LifeCycle investment option is designed to provide New Zealanders with the best of both worlds. From the outset, LifeCycle 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.

8 Option one: LifeCycle retirement years (the KiwiSaver ‘qualifying age’ is when you’ve reached the New Zealand superannuation Under the LifeCycle investment option, your age (currently 65) and been a member of KiwiSaver investment is automatically allocated across the for five years). LifeCycle may also be unsuitable for Income, Inflation and Growth Strategies each year, investors who plan to make a first home purchase based on your age. withdrawal in the short to medium term.

Until you turn 55, your allocation across the three If you have any concerns about LifeCycle, you should Strategies will remain constant and your investment discuss them with a financial adviser. LifeCycle is the will be largely in the Growth Strategy. As you get default investment option and unless you select your closer to retirement, more of your investment will own Strategy allocations (see SelfSelect below), your automatically be allocated to the Inflation Strategy investment will be allocated according to LifeCycle. and Income Strategy. While there are other KiwiSaver schemes which periodically offer reduced risk in the lead up to retirement, the NZ Funds KiwiSaver Option two: SelfSelect Scheme LifeCycle option annually revisits and reallocates each member’s asset allocation based on If LifeCycle is not suitable for you, you can invest their age. using SelfSelect. Under SelfSelect, you choose which Strategy or Strategies your contributions will LifeCycle is designed for investors who want to be invested in (and the proportion to be invested in remain invested through their retirement years and each Strategy). draw down on their savings regularly. It may not be appropriate for investors who plan to withdraw all or If you are thinking about opting out of LifeCycle, you a significant portion of their investment when they should discuss your options with a financial adviser reach the KiwiSaver qualifying age or early into their or NZ Funds.

nz funds : : which kiwisaver scheme is right for you? : : november 209 9 Income Strategy Inflation Strategy Growth Strategy

Aims to provide exposure to Aims to mitigate the impact of Aims to grow your investment income assets. inflation on your investment over the long term by investing over the medium and/or long in income and growth assets. term by investing in income and growth assets.

NZ Funds KiwiSaver Scheme LifeCycle – age-based asset allocation5

age age age 0-54 65 75

NZ Funds KiwiSaver Scheme LifeCycle – current Strategy allocations5

100%

80%

60%

40%

20%

0% 0-20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 years old years old years old years old years old years old years old years old years old years old years old years old years old years old years old

Income Strategy Inflation Strategy Growth Strategy

5 These graphs show the current Strategy allocations under LifeCycle. These allocations may change from time to time. To learn more about the NZ Funds KiwiSaver Scheme LifeCycle option, see the NZ Funds KiwiSaver Scheme Product Disclosure Statement available at www.nzfunds.co.nz.

10 nz funds : : which kiwisaver scheme is right for you? : : november 209 Tomorrow is good. Today is better.

Whatever your personal circumstances, a well structured KiwiSaver Scheme should enable you to accumulate a meaningful proportion of your retirement fund.

It is human nature to procrastinate, especially when effort is required today for something with a long-term and, at times uncertain, payback.

Somehow we think we will feel more ‘motivated’ to begin saving tomorrow. But tomorrow is likely to feel just like today. If we do not have the motivation today, we are just as unlikely to have it in the future.

Unfortunately, when saving for retirement, things tend to get harder over time, not easier. A dollar saved today could be worth $1.606 in ten years time thanks to the power of compounding returns. Most of us have always known it is better to begin a savings plan now, than hope to be able to save more in the future.

Now there is a way you can.

Disclaimer

This document has been provided for information Please also note that past performance is not purposes only. The content of this document is not necessarily an indication of future returns. intended as a substitute for specific professional advice New Zealand Funds Management Limited is the on investments, financial planning or any other matter. issuer of the NZ Funds KiwiSaver Scheme. While the information provided in this document is The Product Disclosure Statement and the Disclose stated accurately to the best of our knowledge and Register contain important information to help you to belief, New Zealand Funds Management Limited, its understand how your money is managed and the risks directors, employees and related parties accept no associated with investing. liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result A copy of the NZ Funds KiwiSaver Scheme Product of reliance on the information provided and opinions Disclosure Statement is available on request or by expressed except as required by law. visiting the NZ Funds website at www.nzfunds.co.nz.

6 Based on an after fees and after tax return of 4.8% per annum.

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