by Diana Clement
Risk: it’s a four-lettered word. But risk can be an investor’s friend. Especially with long-term investments such as Kiwisaver.
That’s because generally the higher the risk the higher the growth potential. The trouble is that most people can’t differentiate between volatility and risk. Risk is the probability of loss, whereas volatility is the fluctuation of prices.
Sharp rises and falls in the value of your Kiwisaver fund - that is, volatility - can be scary to witness. Yet unless you’re retiring or getting your money out for an emergency, a bit of yo-yoing in prices won’t result in any financial loss.
Eventually the underlying investments will return to their earnings justified price level.
Risky or risk free – your choice
Kiwisaver funds come in all flavours. Some take virtually no risk and others are willing to buy slightly riskier investments for the better returns they bring.
The low-risk funds are the conservative ones that hold cash investments, in the middle are funds with cash, bonds and a few shares, and at the riskier end, all shares.
The irony with Kiwisaver and risk is that by choosing the low-risk conservative or balanced funds, investors are risking that their retirement savings won’t even keep pace with inflation. That means the hard-earned money you’re investing now – along with government and employer subsidies – is going to fall in value in real terms, not grow.
Long term a share-based Kiwisaver fund will almost always grow at a faster rate, compounding over time. It might, if history repeats itself grow at an average of 8% a year after fees and taxes, whereas a balanced fund might grow at 6.5%. Over 20 years that makes a real difference.
How big your fund will grow will depend on whether you contribute the minimum $1042 per year (if you’re self-employed), the 2%, 4%, or 8% contributions (for employed people), and if your employer contributes the 2%. Pay increases and payment holidays will also affect the growth.
There’s a useful calculator at Calculatorweb.com/calculators/retirecalc.shtml, which allows you to slice and dice these variables. It’s American, but is more in-depth than most Kiwisaver calculators. Where it says “superannuation”, just think “Kiwisaver”
Another reason to take more risk with Kiwisaver investments is that the money isn’t channelled into single companies. Kiwisaver accounts are funds with various different investments – meaning at least several, if not dozens of eggs in one basket. The more eggs, the fewer chances there are of losing all.
Nor are entire Kiwisaver funds at risk of going broke. They hold real assets and if the provider can no longer continue to operate, the assets still exist. When Asteron, for example, decided in 2010 it didn’t want to be a Kiwisaver provider any more, its clients simply transferred their funds to another provider.
Time horizons the key
The real key to using risk to your advantage is time. If your time horizon is less than 10 years – because you’re retiring soon, or you plan to withdraw your investment for the first home subsidy, then there is a good reason to go safe and avoid the markets being down when it’s time to exit.
If you’ve got 20 years or more up your sleeve, you can afford to ride out the volatility of a riskier fund for the increased growth opportunities it brings.
When risk goes wrong
Although highly regulated, things can go wrong with Kiwisaver. We’ve already seen the Huljich Wealth Management scandal where the founder of the company was paying his own money into the fund to keep it artificially high – fooling investors into believing the investment managers were bigger stars than they really were. No-one lost any money, but some might have chosen another provider had they known the true picture.
Minimise the risk
Kiwisavers who choose the growth and aggressive options can still reduce risk by choosing a fund run by a bigger entity – such as a bank-run Kiwisaver fund.
Another advantage of choosing a larger Kiwisaver provider is that it will have a risk rating from Standard & Poors or Moody’s, which gives you an indication of how safe it is as a financial provider.
The banks and large entities such as AMP are also listed on stock exchanges, which mean they’re subject to continuous disclosure of factors relative to their performance.
Another safety-first approach is to choose a default provider. These providers should be safer because they have to jump through more hoops to get their default status. The default providers are:
• AMP Services
• ASB Group Investments
• AXA New Zealand
• OnePath (formerly ING)
• Tower Employee Benefits
Other Kiwisaver schemes should still be relatively safe. They’re regulated by the Government Actuary, who can step in and tell the scheme’s trustees what to do if he is not happy with the management.