Why the amount you save is more important than the fund you are in

Investing

Martin Hawes points out that the amount you save now will have a huge bearing on what you can spend in retirement, and is probably more important than the returns on those savings

19th Oct 19, 9:49am by Martin Hawes

The advice of the finance industry is that we must save more. Of course, many outside the financial industry would channel their inner Mandy Rice-Davies who, in 1964, famously said of a lying politician, “’E would say that, wouldn’t ‘e.” There is always a suspicion that when the financial industry thinks we should do something, it is much more in their interest than ours.

Nevertheless, in this case, the need to save more is certainly true if we want to have bigger and better retirements. Most of the numbers show that retirement will be fairly meagre if we put 3% to KiwiSaver, even when we are getting that matched by our employer along with a small Government contribution.

The 6% of salary that we pay into KiwiSaver (being 3% of our own money and a similar amount form employers and government) falls far short of the Australian 9% of salary (possibly going to 12%) or the tax incentivised system in the US which often also sees both employee and employer contribute 6% each.

For Kiwis, NZ Super provides a good income base. However, for many, it is not enough by itself: retirement would be a skimpy, even miserable, kind of existence for those who only have NZ Super. Most of us will want something better.

Savings are the key. We need to remember that the savings rate nearly always beats the investment rate. By this I mean that the amount that you save is most likely to be much more important than the investment returns that you get on those savings. If you want to have more in retirement, you need to save more.

It depends on the circumstances and what numbers you use but, most times, someone who saves a lot but gets a low return will end up with more than someone who saves little but gets a better investment return. A simple example: Jess saves $400 per month and gets an investment return of 4% will have $146,013 after 20 years. Vivian, meanwhile, saves $300 per month but get a 5% return. She ends up with $122,237.

That extra $100 per month, even with a lower return, gives an additional of over $23,000.

You can play with the numbers and have any number of different scenarios, but under most circumstances, our saver, Jess, will end up with more than our ace investor, Vivian. Savings matter!

That is why a legislative change earlier this year introduced new and higher contribution rates. Now, as well as the default rate of 3%, you can contribute 4%, 6%, 8% or 10%. Of course, employers are not required to match savings and make contributions over 3%.

The savings rate being more important than the investment rate does not mean the right fund is unimportant. We still need to find our Goldilocks fund - one with not too much risk and not too little risk; one that is just right.

But, more importantly, we do need to save as much as we reasonably can into that Goldilocks fund.

However, KiwiSaver is not always the right fund for any additional cash that can be saved. We have to remember that KiwiSaver is illiquid – whatever you put in cannot usually be taken out before retirement age.

Be very careful before you put more money into KiwiSaver. Certainly, put an amount into KiwiSaver which attracts the maximum contributions from your employer and government but think before you go beyond this – you are unlikely to be able to get your money out again.

KiwiSaver is an excellent savings and investment vehicle: it has lower fees than other comparable funds, it is well regulated and it is easy to compare fund performance. But there are other savings vehicles for those who think it possible that they may need some cash before retirement: you can use other non-KiwiSaver funds or have a financial adviser build a bespoke portfolio for you.

Those who are self-employed or who are in business need to be especially careful – businesses often need capital either for expansion or to get through a sticky patch and it will be cold comfort if such a need arises but the capital that you have tucked away remains unavailable.

Those saving for their first home can happily save more – they will be able to withdraw. Others may also be in a situation where they can be confident that they will not need the money: they may be in a job or profession that is certain, or they may be getting within a few years of retirement.

I encourage more saving but, after you have contributed enough to get the maximum employer and government contributions, do think about where you put any additional money. KiwiSaver will suit some but not those who think it may be necessary to make an early withdrawal.

*Martin Hawes is the Chair of the Summer Investment Committee. The Summer KiwiSaver Scheme is managed by Forsyth Barr Investment Management Ltd and a Product Disclosure statement is available on request. Martin is an Authorised Financial Adviser and a Disclosure Statements is available on request and free of charge at www.martinhawes.com. This article is general in nature and not personalised advice.

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18 Comments

by Gummy Bear Hero | 19th Oct 19, 11:23am 1571437410

Martin ... thanks to the Gnats , and now to this Labour Coalition , Kiwi Saver is rapidly morphing into Kiwi Build Saver ... a scheme to create the deposit needed to join the throng clamouring for a house ...

... if KS is to survive and prosper , it ought to be reset along the same lines as the Australian compulsory super scheme ... compulsion ... better tax treatment . .. fewer opt outs ..

by Good Samaritian | 21st Oct 19, 8:32am 1571599931

Agreed.

Otherwise ex banksters like Jonkey, who find themselves in charge, manipulate the system to use what should be long term savings for short term profits to pamper to his elk.

Would be good to allow people to self manage their funds, as they do in Aussie. The only option available here is with Craig Investment Partners, but they charge an additional 1% management fee for that privilege, in addition to set brokerage fees for transfers from one investment to another. Under a low return environment we are in, these fees are extortionate, and not worth embracing the privilege of self managing.

Hopefully Simplicity can help us out here!

by Mr Ed | 21st Oct 19, 12:44pm 1571615062

Did you mean Bankster Gangsters ?

As for Kiwisaver providers this is the new financial advisory scam. Extortionate fees making operators wealthy at savers expense. Look at the nature of premises some of them occupy.

by printer8 | 19th Oct 19, 12:29pm 1571441355

As someone four years retired and, as far as I am concerned as to my wants, comfortable; to me, the most important things in ensuring a comfortable retirement is firstly about sound decision making, being a little prudent, and keeping a balance in life.
The points made are very sound but also need to be considered in light of those three criteria. Thinking that it is a necessity to focus on starting saving for retirement over 40 years from the day one start working is simplistic and not necessarily so.
Focussing early on a first home for one’s family and their security is sound. It is also important that one keeps a balance in life and a family times including holiday time is critical.
The ability to save for retirement and the amount saved is not going to be consistent through one’s lifetime. For many of my generation of much criticised baby boomers, much of their saving came from using the equity in their home to invest in rental property in the mid to later part of their working life.
Yes they did well out of both home and rental property ownership. There is a very good but overlooked reason for this - the equity multiplier effect. What this is about is one has say 25% equity in a property and over the long term the property increases in value by a very very modest 3%, then as one’s mortgage remains stable, the increase in one’ equity is 4 times that rate of increase I.e. 12% (and yes, in most circumstances, still tax free). I appreciate this is a simple explanation just like the worked savings example. I hear posters screaming mortgage interest, maintenance and rates - well as a homeowner they are in lieu of rent, and for a property investor they are covered (more so?) by rent.
Note that it is because of this factor I am supportive of those who can’t afford a home, to use their KiwiSaver to purchase rental property.
When I was a kid we had Post Office Savings Account and we were encouraged to save at least sixpence a week which would go to our secure retirement. My first lesson in not believing everything you are told:)
I agree totally that any one from their first day of work who thinks that all one has to do is to save 3% of their salary and they will be secure and comfortable for life. That is so, so short.

by Uninterested | 19th Oct 19, 4:18pm 1571455084

Govt super required a 6.5% employee's contribution. So yes, 3% is low. Once out of govt empoy, I put away 3% into Kiwisaver and at least 3.5% into term deposits. So its all looking very good. Low term dep rates now are a bit of a blow, but all said and done if everyone has less money in future, prices will come down to match that otherwise nothing will get sold.

by printer8 | 19th Oct 19, 5:15pm 1571458517

Agreed, uninterested.
Unfortunately we are not likely to see a superannuation scheme as generous as the old GSF which closed off to new members in 1992.
Not only was the employer's nominal contribution 6.5% generous, having a defined benefit what ever happened, the provision for early retirement, and being probably the most rock solid investment one could find (the government as payee and the scheme defined by Act of Parliament). KiwiSaver falls well, well short on all of these criteria.
I trust that you have been able to maintain your GSF; I am pretty sure there are provisions for doing so in your situation. As the nominal defined return was calculated at the then/historical rate of 7% it is a pretty good (and untaxed) return compared to the current rates of similar risk.
I know that there are plenty of those of my age who withdrew and now very sorely regret having done so.
I also agree despite being 6.5% employee and 6.5% employer contribution, this has tended to provide a very good additional retirement income, but for those regular trips abroad, on its own it is not sufficient.

by muzled | 19th Oct 19, 5:44pm 1571460289

It'd be interesting to know which companies even offered a super scheme nowadays.

My employer matches your input upto 5% for the first 5 years then 7.5% after 5 years plus returns which for the last ten years have averaged double figures.

Needless to say I'm putting in the maximum allowed of 15%. (have to be employed for 7 years to get the full amount they put in, up until then it's a little less for each year you're there).

There are people that have been there most of their working lives and I'd guess is they'll be getting more from the super scheme than they will be from their salary.

by Uninterested | 20th Oct 19, 2:40pm 1571535631

Yes. if you were in it for more than 10 yrs you did not have to take your money out. And you can start getting money back (albeit rather modest amount in my case) at age 50.
Some people I worked with did not contribute towards it. Can you believe that?

by Jarlaith | 19th Oct 19, 6:36pm 1571463402

"Low term dep rates now are a bit of a blow, but all said and done if everyone has less money in future, prices will come down to match that otherwise nothing will get sold.”

Can you provide evidence of this?

by Uninterested | 20th Oct 19, 2:49pm 1571536141

On its own. No. It would be combined with reduced inheritance money going to children and reduced expenditure. But obviously it must reduce spending power. So for example, some of those contemplating going into rest homes will not be able to pay as much. Prices are likely to drop.

by Laminar | 19th Oct 19, 4:50pm 1571457010

Nice write up

by Audaxes | 19th Oct 19, 12:29pm 1571441388

The idea that “low interest rates justify high stock valuations” is really a statement that “low interest rates justify low expected stock returns as well.” Those high stock valuations are still associated with low prospective future stock market returns.

Worse, the notion that “low interest rates justify high stock valuations” assumes that the growth rate of future cash flows is held constant, at historically normal levels. If, as we presently observe, interest rates are low because growth rates are low, no valuation premium is “justified” by low interest rates at all.

Presently, the combination of record low interest rates and record high stock market valuations does nothing but add insult to injury.

Endowment-to-Spending

One of the concepts I introduce in Strategic Allocation is the idea of an “Endowment-to-Spending Multiple.” The estimated E/S Multiple answers the following question:

Suppose an investor has accumulated a lump-sum of savings, and wants to finance a long-term stream of real, inflation-adjusted spending. How large must the initial “endowment” be, as a multiple of annual spending, to finance those future outlays, assuming that it’s passively invested in a conventional portfolio mix (60% S&P 500, 30% Treasury bonds, 10% Treasury bills)?

As a convention, we assume a 36-year horizon, representing a 64-year-old investor hoping to fund spending over a potential 100-year lifespan. There’s nothing special about that horizon, and we obtain similar results using any horizon beyond about two decades, because long-dated distributions have very little impact on the total present value.

The chart below presents our estimate of the Endowment to Spending Multiple going back to 1928. The equity market return estimates are based on the Margin-Adjusted P/E before 1950, and the ratio of nonfinancial market capitalization to corporate gross value-added after 1950. The bond market return estimates use the yield to maturity on long-term Treasury bonds at varying horizons.

You’ll notice that the current E/S Multiple is over 31, which basically says that if you insist on passively investing a lump-sum in a conventional portfolio mix in order to fund your retirement, you’d better already have nearly all the dollars you hope to spend, because the prospects for significant long-term capital growth from present valuations are dismal. Contrast this with 2009, when the estimated E/S multiple was 18, or with 1982, when the E/S multiple fell to a record low of 9. Link

by lastlegs | 19th Oct 19, 3:01pm 1571450486

does the 400 a month savings include what both contribute?otherwise it looks like Jess had a rascally employer who didnt match her contributions,if she put in 96000 dollars and only got 146000.I would think 146000 of year2039 dollars would be worth 96000 dollars!

by Martin Hawes | 19th Oct 19, 6:31pm 1571463088

Lastlegs, I was not saying that these were necessarily amounts going to a KiwiSaver account - I was just giving an example using total savings to make the point that the more you can save in total the better off that you will be and that a higher investment rate of return will not make up for a low savings rate in most cases.

by matt7879 | 19th Oct 19, 7:42pm 1571467350

i have a company elite sales group ltd selling gps trackers and cctv cameras to our customers are u able to finance residential and busines customers at all. matt

by Gummy Bear Hero | 20th Oct 19, 12:17am 1571483855

Nice bit of spamming !

by lastlegs | 19th Oct 19, 10:06pm 1571475997

yes,you are right,in fact you advise against putting more than the basic 3% into kiwisaver but increase savings to another fund or you are likely to have a meagre amount on retirement.if we agree it is inadequate why repeat the mistake and put it into another fund without the benefit of a matching contribution.

by Carlos67 | 21st Oct 19, 12:58pm 1571615928

Simple math really and you don't need Kiwisaver just a normal bank account that you put money into and never withdraw it, well that worked up until very recently but now the interest rates are so low its kind of put paid to that. Go back a few years and do some compounding interest rate calculations on decent interest rates. The simple rule is you cannot touch it until you retire, pretty much impossible.