This is the third and final instalment in a series of articles looking at the important assumptions and decisions one needs to make when forecasting what nest-egg one might achieve with a long-term investment plan using a KiwiSaver scheme.
KiwiSaver is huge with 2.7 million New Zealanders involved as at 31 December 2016 so we can't afford to make suboptimal investment decisions.
In addition the issues around saving for retirement are probably more critical today than they have ever been for two reasons.
Firstly, superannuation policies have changed - back in the day the most popular type of superannuation scheme was the defined benefit scheme where what you got at retirement was largely unaffected by what investment markets did while you were saving.
The risk that markets might crash the year before you retired was assumed by the company supporting the defined benefit scheme, in theory anyway.
Today however most companies will not accept taking on that sort of risk.
Consequently defined contribution schemes have replaced defined benefit.
One of the big differences between the two schemes is that the employee takes the investment risk.
Today the success or otherwise of your saving for retirement strategy is primarily a function of how much you save, how long you save for, the performance of investment markets and fees.
Now the risk of a bad result falls squarely on the shoulders of the individual and the individual makes most of the important decisions.
Accordingly one needs to understand how returns and savings relate to outcomes. Specifically one needs to reconcile how much you want at retirement with how much you can save and how much it will earn.
If you overstate the latter you may not save enough and therefore you may not achieve the outcome you expected.
In this article we will put all those factors together to answer, using realistic assumptions of forecast returns, some Frequently Asked Questions about KiwiSaver.
In the first report in this series we noted the tendency of many fund managers to take an optimistic view of future returns so as to make their products look attractive and their fees look low.
An excellent example of this crossed my desk last month where a fund manager presented a "hypothetical" KiwiSaver account for an investor aged 35 saving via a growth orientated KiwiSaver account.
The "hypothetical" scenario used a very hypothetical 8 per cent return, after fees and after tax. Compare that with the 4 per cent or so implied by the McKinsey/AQR/Bogle/Siegel analysis.
The fund manager produced a pie chart showing how attractive Kiwisaver was in that an individual need only contribute $98,781 to achieve a sum in retirement of $627,000.
That analysis would properly model reality if the future long term post-tax, post fee return was 8 per cent pa.
As we showed a few weeks back that is the sort of alternative truth a certain President of the USA is likely to represent as being reality.
Using a more realistic 4.1 per cent pa growth rate we get a new "hypothetical" result. In this less "fantastic" scenario the terminal sum is a much more modest $320,000 and growth, significantly, is just $140,000.
Putting things another way, in a low return environment, what you end up with is very much a function of what you, your employer and the government contribute - of the $320,000 terminal sum some $180,000 or 56 per cent is made up of contributions rather than returns.
To add some further perspective to the way returns are shared I have also estimated the total value of the management fees that Ms KiwiSaver will have paid over the life of the savings plan.
These fees total $67,000 which is almost half the investor's compounded return. (Note that the investment return is after these fees have been deducted).
Now let's provide some realistic answers to some Frequently Asked Questions. The answers of course depend on how much you are saving, how long you are saving for and what sort of portfolio you have but readers will get a feel for orders of magnitude. The scenario we are modelling here is for an individual earning $75,000, aged 35, retiring at 65 and investing in a balanced Kiwisaver portfolio.
Question 1: How important are fees in determining what I am likely to have in retirement? Specifically, if I opt for a Kiwisaver provider with a 0.4 per cent pa fee structure how much more am I likely to have in retirement than if I opt for a provider with the industry average fee of around 1.4 per cent?
Answer: The terminal sum under this scenario increases from an estimated $310,000 to an estimated $350,000 ie an increase of more than 10 per cent.
Question 2: If I increase my savings to 4 per cent of my salary how much more am I likely to have when I retire?
Answer:The terminal sum increases to an estimated $366,00.
Question 3: I am nervous about stockmarkets and think I have a below-average risk profile. What is the likely impact on my nest-egg if I choose a more defensive asset allocation?
Answer: If you opt for a higher weighting in bonds, say 60 per cent, with 40 per cent in property and shares the likely terminal sum falls to an estimated $290,000 versus an estimated $310,000 for a balanced portfolio.
Question 4: I am self-employed - what is my terminal sum likely to look like without the employer contribution?
Answer:The employer contribution is significant - the terminal sum without the employer contribution falls to an estimated $197,000.
Question 5: How might my nest egg be impacted if I choose to retire at age 69 instead of 65?
Answer: By letting your savings grow for an extra four years you benefit from the compounding effect on a large sum with the effect that the terminal sum is likely to increase from an estimated $310,000 to an estimated $364,000. Note that this assumes employee contributions stop at age 65 as does the government Kiwisaver subsidy.
Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent Sheather may have an interest in the companies discussed.