It’s anyone guess what the world will look like in 40 years time – climate change might have made Earth uninhabitable, or Donald Trump might have started WW3 and ended civilization as we know it.
Assuming neither of these catastrophic scenarios occur, you will need to have saved a sizable chunk of money for your retirement. Even though retirement might be a long way away for you, a couple of smart decisions now could help you avoid having to live off baked beans when you’re old.
This is where KiwiSaver comes in. For most young people, this will play an important role in ensuring your retirement is comfortable. It can also help you to buy your first home.
Free money (almost)
We’ve all seen popups telling us we’ve won a prize or received emails from Nigerian princes offering us free money if we help them move their millions.
We all know there’s no such thing as a free lunch.
If you contribute money to your KiwiSaver, the government and your employer will also contribute. This is essentially free money that you wouldn’t receive if you weren’t in KiwiSaver.
The government contributes a maximum of $521.43 a year; you get this by contributing at least $1042.86 of your money. According to a recent Sorted.org.nz article, only 43% of the over two million KiwiSaver members received the full payout last year. If you top up your contributions for the year between 1 July 2015 and 30 June 2016 to $1043 or more by June 30, you can guarantee that you receive the full payment.
If you’re not earning enough to contribute $1,043 a year, it’s still a good idea to provide what you can as the government will contribute 50c for every $1 you contribute up to that point.
Your employer will contribute 3% of your earnings on top of your contributions.
KiwiSaver is far from a perfect system, but for most people, the benefits listed above will make joining a smart decision.
Choosing a type of KiwiSaver fund
In a classic episode of The Simpsons, Homer and Barney are competing to see who gets to take a trip into space. Barney becomes drunk on non-alcoholic champagne and Homer wins by default.
“DEFAULT!” he shouts, “The two sweetest words in the English language!” . While “default” is music to Homer’s ears, it might not be ideal for you and your KiwiSaver balance.
Word to the wise, the following section contains a bit of finance jargon. What type of KiwiSaver scheme you’re in makes a huge difference and you don’t need to be the wolf of wall street to understand it. Take a deep breath, and read on…
If your employer doesn’t have a KiwiSaver provider, you will be “defaulted” into a conservative scheme. This is a very safe scheme that will have most of its money in cash and government bonds.
These type of investments offer little risk but usually lower returns. You almost certainly won’t lose what you invest, but you might make more in a different fund. Sorted suggests that if you are 12 years or more away from cashing in your KiwiSaver, you will benefit from being in a scheme with a higher percentage of growth assets.
“Growth” assets include shares and property trusts. These type of assets are likely to grow more over the long run, but will experience more volatility in the short and medium term (the next few years). In one particular year, these assets could break even or decrease, in the next they could grow by 20%.
Small differences in the yearly rate of return add up to large amounts over the course of your working life. According to sorted “aggressive funds” with mostly shares and property return an average of 8% while conservative funds return an average of 5%.
If you invest $2,000 a year for 40 years and get an average return of 5% you will end up with $254k. If that same $2,000 per year instead gets an average return of 8%, you would end up with $559k, $306k more!
If you have a KiwiSaver scheme which is predominately “risky” assets, your balance may fall over a period of months. Don’t panic! Share markets fluctuate, and this is expected to occur on occasion. However, if your KiwiSaver account losing money in the short-term would keep you up at night, it may be best to avoid the riskiest schemes.
There are plenty of good reasons to change funds or providers. Two of them are: deciding you want to take on more or less risk, or moving to a fund with lower fees. However, you don’t want to be switching often based on short-term results. Picking funds based on short-term results is like trying to catch a big wave after it’s already crashed into shore.
A good place to start when choosing a fund is with funds that suit your risk profile (how much risk you can handle). This page on sorted.org.nz can help you choose which type of fund is right for you. This leads me to another thing about KiwiSaver that isn’t talked about enough…
KiwiSaver fees, the silent killer
All KiwiSaver funds charge fees to the customer. KiwiSaver Fees come in the form of a fixed annual fee and a percentage of your account balance. In general, the higher the percentage of risky assets in the KiwiSaver scheme, the higher fees will be.
The difference between paying yearly fees of 1% or 2% might not sound like a lot, but over the long run this can have a huge effect on your KiwiSaver balance.
You can use the sorted.org.nz KiwiSaver fees calculator to compare funds. If you look at the “growth” or “aggressive” funds and sort by highest fees, you can see that some funds charge a ridiculous amount.
If you have 40+ years to retirement, the fees of some funds will decrease the amount you’d be paid out when you retire by 20% or more! The difference between a high fee KiwiSaver fund and a low fee KiwiSaver fund can mean tens of thousands less in your pocket by the time you retire. It could be the difference between living comfortably and eating baked beans on toast every day.
Almost no one I’ve spoken to about KiwiSaver mentioned that fees were a factor in their KiwiSaver decision. Some people didn’t even know they were a thing! More needs to be done to make people aware of what an effect they could have on your long term KiwiSaver success.
- If you aren’t in KiwiSaver, think about opting in to take advantage of the government and employer contributions.
- If you are, make sure you know what type of fund you are in and how much you are paying in fees.
- Do you some research to determine whether you are in the best fund for you.
- Consider switching funds if you think you could benefit from being in a fund with a higher percentage of risky assets or If you think you are paying too much in fees.