Growth on growth

There’s a powerful message for all investors here, says Holm.

Q I was watching YouTube about investing. The guy was saying that after 13.4 years, your investment is making more than you are putting into the investment! I presume that’s the same for any investment. But most people, including me, didn’t know this. Can you explain how it works?

A What he’s pointing out is that, once your savings have become reasonably large, even a fairly modest return adds up to big dollars.

Let’s say you’re putting NZ$400 a year into KiwiSaver, and your fund makes a 7 per cent return.

Early on, your savings total only NZ$1000, so the return is NZ$70 a year – much smaller than your $400 contributions.

But some years down the track, you might have NZ$10,000. The same 7 per cent return will grow your
savings by NZ$700 – beating your NZ$400 in contributions. In the video, the guy assumes your contributions
grow as your wages increase – which is fair enough. But even so, your returns will grow faster in most years.

In the example he uses, after 13.4 years the return is bigger than your contribution. And after another 10 years, the return is twice as big as your contribution. But under different assumptions, those periods would be different. There’s nothing magical about 13.4, even though it sounds a bit magical!

The main point is that compounding growth seems slow at first, but it gets more and more powerful. You get returns not only on the amount you are saving, but also on the returns you earned in earlier years.

There’s a strong message here: start saving – or boost your saving – now! Every year makes a huge difference. Let’s say you reach 65 – and plan to retire then – with savings of NZ$400,000.

If you had started a year earlier, and your savings are earning a fairly modest 4 per cent after fees and tax, you would have had NZ$416,000.

And if you had started three years earlier, you would have had NZ$450,000. That’s NZ$50,000 extra to have fun with, in retirement!

Switching KiwiSaver providers

How to make a choice. This letter came in before the Covid-19 share market plunge!

Q My son (six) and I have KiwiSaver with Kiwibank, simply because I like the ease of accessing everything in one place. It occurs to me this isn’t the best way to make this decision, but I don’t know where to find any unbiased information on how to assess and choose a scheme based on performance, or if there is another measurement to consider?

A You’re absolutely right about convenience not being a good reason to have your KiwiSaver account with your bank – although it’s a common enough reason.

Actually, I think it could prove to be a problem when – not if, but when – there’s a major downturn in share markets, and many KiwiSaver balances fall a fair way.

People who see their account balances regularly, when they log onto their bank website, are more likely to panic and move to a lower-risk fund at exactly the wrong time.

It’s good to check your KiwiSaver balance every few months, but not daily. And even then, remember to hold your course in rough seas.

So how can you find unbiased info on the best fund for you? Go to www.smartinvestor.sorted.org.nz and click on Compare and then KiwiSaver and Managed Funds. You then choose KiwiSaver and the type of fund you’re in.

But first, I suggest you read the writing underneath, and check that you and your son are in the right risk levels for you. Then you can compare the KiwiSaver funds at that risk level.

Scroll down a little, and on the right, you’ll see a ‘Sort by’ box. The options include ‘Return’, but I strongly suggest you skip that. Research shows, over and over again, that funds that have performed well in the past won’t necessarily keep doing so.

Instead, choose ‘Fees, lowest first’. Then look through several funds with low fees. For more information on a fund – including its top 10 investments – click on the fund name and scroll down.

Advice is the same, whatever your age

This was right after the Covid-19 share market plunge in autumn 2020.

Q Help! I turned 65 in November last year and was planning to move a large part of my bank KiwiSaver (40 per cent in a conservative fund and 60 per cent in a balanced fund) into a conservative fund with a private investment company, where I already have a modest amount that has been earning very good interest.

However, I have been watching in horror over the past few weeks as my KiwiSaver has lost NZ$15,000. I feel like a possum caught in the headlights as I have no idea what to do. I had planned to retire in less than two years.

Should I move most of what’s left of my KiwiSaver (NZ$232,000) into the private investment company fund, as I had planned, or just move it all into my bank’s conservative fund?

All the advice I hear from the experts advising KiwiSavers to stay put is for younger people. But what about people like me who are almost at retirement?

A Relax. You’re okay. That ‘stay put’ advice applies to most people of all ages – at least for the next couple of months, although there might be some wise moves for you to make after that.

This is a good opportunity to check:

• Whether your KiwiSaver or other fund is the right risk level – low risk if you plan to spend the money soon, but higher risk for later spending.
• Whether you can tolerate the volatility of your fund.

You seem pretty good on the first count. Your conservative fund money can finance the early years of your retirement, and the balanced fund money can be for spending later – right on into your nineties, perhaps. But if you’re a horrified possum (sorry, but I couldn’t resist!), perhaps you just can’t cope with volatility.

The trouble is that we haven’t seen significant market falls for years, and people aren’t used to it. The markets will rise again. They always do, usually within a year, although it can take longer. So, I urge you to ignore what’s happening.

But if you must do something, over the next few months consider gradually moving your conservative fund money into your provider’s lowest-risk defensive KiwiSaver fund, which will hold mainly cash and pretty much never drop in value – except perhaps a tiny bit.

If your provider doesn’t have such a fund, move to a provider that does. The KiwiSaver Fund Finder at www.fundfinder.sorted.org.nz lists defensive funds – sometimes called cash funds.

With your balanced fund money, try to be brave and leave it where it is. It will recover in time, and grow more than in a lower-risk fund.

Nor would I rush into the other company’s fund. Its future returns won’t necessarily be any higher than where you are, and it might charge higher fees, which eat into returns. For info on fund fees, see the Smart Investor tool on sorted.org.nz.

Just to put things in perspective, your NZ$15,000 loss is about 6 per cent. Over the past few years, you will have gained considerably more than that.

First-home buyer

Here’s a letter from a risk-runner.

Q I’m a single 45-year-old lady in fulltime work. I’ve been in KiwiSaver since it started in 2007. I currently have NZ$200,000 in it, as I knew I’d use it when I find a house.

It’s in a growth fund.

I found a house recently. I’ve put an offer on, and I’m still waiting for it to be accepted. While waiting, I saw that my KiwiSaver balance dropped to NZ$196,000.

Do you think I should move the remaining NZ$196,000 to a conservative fund or just let it stay there? I can still borrow the NZ$4000 I’ve lost in KiwiSaver. The property has only been at market one month so they may take longer to accept me as buyer.

A You already know my short answer. When I got your letter, last Wednesday morning, I replied: “I will answer you in more depth in my column this Saturday. But in the meantime, I would move to a conservative fund as soon as you can.”

Normally, I would yell at someone planning to switch to a lower-risk fund after their balance has fallen. ‘Stop! Stay put through thick and thin and you’ll end up better off.’ But you will probably be cashing in your investment in the next few weeks, and there’s too big a chance your balance will fall further in that time.

Okay, now it’s time for the tut-tutting – although perhaps you are new to the column and can’t be expected to have read one of my repeated messages. So here it is again:

“When you get within 10 years of spending your KiwiSaver money – on a first home or in retirement – it’s not wise to be in a growth fund. You can never count on your balance not falling and staying down for several years.”

Instead, use lower-risk funds. It’s all about avoiding what has happened to you. Actually, you’re lucky that your balance has dropped only 2 per cent. By the time this column is published it might have dropped much more in a volatile market week.

Then again, the markets might bounce back. You might write angrily to me that, if you had stayed put, your balance would have been more than NZ$200,000 by the time you have to hand over the money. Write away. I don’t mind!

While growth funds always grow over the long term, they can be extremely volatile in the short term, and despite lots of speculation nobody knows what will happen next.

Some people in your situation would be prepared to take the gamble. But research shows that most people dislike losses more than they like gains.

As it happens, you’ve been lucky over the longer term. KiwiSaver growth funds have all grown healthily in recent years, but such long steady growth is highly unusual. Neither you nor anyone else planning to spend their KiwiSaver money in the next decade should expect that to continue.

Congratulations, though, on using KiwiSaver to grow a decent house deposit.

Boosting your KiwiSaver

A keen saver gets keener. It’s August 2019.

Q A downturn in stock markets is a good time to double-up investing in KiwiSaver! I am putting away 6 per cent through salary and adding 12 per cent extra through direct debit to my provider. I have 20 years until I can access KiwiSaver.

A Your email came in when the New Zealand share market and others around the world were wobbling, but it was too late for my last column. Since then, the markets have settled down, or at least they had when I wrote this. By the time you read it, who knows?

As I say so often, it’s not wise to try to time markets. But if you insist, you’re doing it the right way – buying more when the market falls. Too many people sell during a downturn and therefore receive low prices for their shares. Ouch! Anyway, I hope you stick with your large KiwiSaver contributions.

There’s an argument for putting the extra money in a similar non-KiwiSaver fund instead. You’re already getting the maximum KiwiSaver incentives – the 3 per cent employer contribution and maximum government contribution. And outside KiwiSaver you can access the money if you – or perhaps a family member in crisis – needs it.

But if that’s not an issue for you, adding to KiwiSaver is great. It’s simpler, the fees are probably lower, and the government scrutiny is tighter. And some people like the inaccessibility. They’re not tempted to blow the money on unnecessary stuff.

You’re putting a huge 18 per cent of your pay into KiwiSaver.

While you can’t do that through pay deductions, these days you can contribute 3, 4, 6, 8 or 10 per cent of your pay that way.

Make other contributions directly to your provider. Doubling your contributions – from say 3 to 6 percent – won’t double the growth in your KiwiSaver account, because the employer and government contributions won’t grow.

Even so, raising your contributions can make a big difference. Here are a couple of examples, using the KiwiSaver Savings Calculator on www.sorted.org.nz. I assume the person is an employee who has been in KiwiSaver for five years.

A 25-year-old in a growth fund, currently earning NZ$50,000, will have NZ$655,000 at 65 if they continue with 3 per cent contributions. But if they switch to 6 per cent, they will have NZ$930,000.

A 45-year-old in a balanced fund, currently earning NZ$80,000, will have NZ$210,000 at 65 if they continue with 3 per cent contributions. But at 6 per cent, they will have NZ$300,000.

Those amounts are not adjusted for inflation.

© A Richer You: How to Make the Most of your Money, by Mary Holm. Published by HarperCollins New Zealand.