By Martin Hawes*
Government is making changes to default KiwiSaver schemes. Probably the most important of these changes is that default funds will no longer be conservative funds, but instead, those who join KiwiSaver without nominating a fund will be placed in a balanced fund.
I think this is a good move. A balanced find is likely to suit more people than a conservative default fund and, for those who stick with their default fund, the returns (and, therefore, account balances) are likely to be significantly greater if the default is balanced.
However, there will still be quite a lot of KiwiSavers in the wrong fund and the Financial Markets Authority will not allow default providers to fall asleep at the wheel. Default providers are currently obligated to encourage their members into the right fund and I am quite certain that this obligation will continue.
Nevertheless, many of those who have been dumped in default funds have proved hard to shift out of conservative funds. All default fund providers try to improve financial literacy and get their members into a fund with the right risk profile, but some are more successful than others.
To be fair, default providers have improved their financial literacy efforts – more KiwiSavers are shifting out of default. However, there are still many people remaining in default funds these are often quite hard to move: it is reasonable to assume that those who join KiwiSaver without nominating a fund often care less than other members who have taken a few minutes to decide on a fund.
A balanced fund will be better than a conservative fund for more of those who remain in default funds. There will be some people who ought to be in conservative funds but in the 12 years of KiwiSaver’s existence, returns have been significantly better with more risk. Of course, during difficult times as we have at the moment, volatility will be greater. However, investment theory says that the more risk you take the better your long run returns. KiwiSaver has seen this theory borne out in practice.
Government does have another option: they could require default providers to take a “lifestages” approach. This “lifestages” method means a provider chooses what fund you should be in according to your age. This means that 22-year olds (with, perhaps, 50 years of work and investing ahead of them) are placed in an aggressive fund while a 60-year-old (with, perhaps five years until retirement) is put in a conservative fund.
In my view this is a very blunt instrument – age is not the only arbiter of the amount of risk you can take. First, age is supposed to be a proxy for the length of time before withdrawal. However, age does not always indicate time to withdrawal: the 22-year-old may withdraw all funds to buy a house; the 60-year-old may not plan to retire until age 75.
Second, the “lifestages” method takes no account of how people feel about risk. When times get rough, there are always a lot of people who get rattled out of the market, effectively selling growth investments at the very worst time. It is true that such nervous KiwiSavers cannot withdraw from KiwiSaver but people who find they cannot tolerate watching their account balance decline can move from a risky fund to a less risky one. This effectively means that they are selling growth assets at just the wrong time.
The default funds were always meant for the short-term while people took a little time to make up their minds. It is clear now that many of those in default funds are not going to easily shift to something more appropriate. Given that there is a hard core of people stuck in default funds, a balanced fund is likely to be more suitable as a reasonable halfway house between conservative and aggressive.
Nevertheless, this does not mean that default providers will be able to go to sleep – they must continue their financial literacy efforts until everyone is in the right fund with the right amount of risk. And, even with balanced as the default option, they will still have a lot of work to do.
*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. Summer competes with banks and other KiwiSaver providers.