Missing Out On Millions: The Default Fund Disaster
Could it be you?
6 October 2021
Kiwis are missing out on millions of dollars in retirement savings because their money’s been sitting for years in low-return default funds, says Binu Paul. Are you one of them?
Would you pass up the opportunity to make an additional $10,000?
No? Of course, you’re thinking, ‘Where’s the catch? What would I need to give up to make that kind of money?’
The good news is that if you’re contributing to KiwiSaver, you’re already ‘giving up’ (so to speak) a part of your salary or wages to get some investment returns in the future.
The bad news is that if you haven’t chosen your KiwiSaver fund carefully, then you may be missing out on thousands of dollars.
Small sacrifices, big fortunes
Let’s take the example of Sarah and Ashlee, who both started contributing to their KiwiSaver accounts back in September 2007, at the minimum contribution rate of 3 per cent of their salaries of $72,000 (about $2,200 each year).
Today, Sarah’s KiwiSaver balance is about $58,000 and Ashlee’s balance is about $68,000.
Ashlee is better off by $10,000 dollars – not because she put any more of her salary into KiwiSaver than Sarah. The stark difference in their fortunes simply comes down to the investment returns their respective funds have been making over the past 10 years.
When she signed up to KiwiSaver, Sarah didn’t make a choice of which fund to invest in. So her contribution was be invested in one of the ‘default’ funds randomly chosen for her.
It’s been earning just under 5 per cent each year, on average. There were nine of these ‘default’ funds available to Kiwis, typically invested in a low-risk, ‘conservative’ manner. [Recent changes reduced the number to six and they’ll all be invested in a ‘balanced’ fund.]
It’s worth shopping around
On the other hand, Ashlee was encouraged by her mum to shop around for a fund that suited her circumstances.
After having taken into account her stage in life and her appetite for taking risks, and comparing some essential details (such as fees and returns), Ashlee started off her contributions in a ‘growth’ type fund. This fund has been earning an average of 7 per cent each year.
Take a guess at how different their KiwiSaver account balances will be by the time the two 30-somethings retire at 65?
If you assume wages rise by 2 per cent a year and everything else remains the same, Ashlee will be better off than Sarah in retirement by a whopping $520,000. All that from simply taking the initiative to invest a bit more time (not money!) in making a smart choice of fund.
Sarah can point her finger at a number of reasons for not choosing the right fund – time, a lack of interest, and how hard it is to switch, but her decision not to swap comes with a hefty price tag – just over half a million dollars.
Act now and save
It’s never too late to make an informed choice. In fact, the longer you put off making a decision, the more expensive that decision becomes.
Ten years on from when KiwiSaver started, close to half a million Kiwis, like Sarah, are still invested in default funds.
Default funds were designed as a temporary ‘parking’ spot to give members time to choose an appropriate fund. Members were expected to then switch to another fund that was better suited to them.
However, the outcome today is appalling. This feature has turned out to be badly misused, leading to collective millions of dollars in investment savings under-returning over the past 10 years.
In years to come, if this situation carries on, it will cost New Zealanders hundreds of billions of dollars in retirement savings.
The number of people in default funds may look staggering, but not all of the money may be in the wrong place. By accident, some people might suit the conservative nature of default funds. For the rest, however, default funds are fatally inappropriate.
Get set, switch!
There are more than 20 KiwiSaver providers, offering close to 250 different funds to choose from. Each provider has a range of funds (of varying risks).
People should first decide the type of fund they want, then pick a specific provider offering that type of fund.
Take responsibility for your own financial decisions. Your KiwiSaver balance will likely be your second largest asset in retirement, after your house. So have some respect for your hard-earned dollars and invest some time now.
In my view, KiwiSaver providers have a responsibility to ensure they’re doing the best by their members. After all, they’re charging fees for the services they offer, and members should get their money’s worth.
So, if you haven’t had any help or guidance from your provider, get in touch today. If they don’t seem keen to help, move to another provider who’s happy to.
At the very least, check if you’re still in a default fund and ask if you’d be better off switching to a more appropriate fund.
If you need help, talk to a qualified financial adviser. If you’re worried about what you might end up paying for that advice, compare it to what you stand to lose.
First published Autumn 2018
Story by Binu Paul
Binu Paul is co-founder of www.pocketwise.co.nz and founder of SavvyKiwi.co.nz. He’s spent the last 19 years in funds management and investment research, with the past four years in technology development. He also consults to a number of financial advisory practices and the Financial Markets Authority. The views expressed here are solely personal and do not reflect that of any other individual or entity.
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