191,000 people could miss out on $72,000 each by retirement, writes John Body, managing director of ANZ Wealth.
While much of the retirement savings debate has been about the age of entitlement and whether or not KiwiSaver should be compulsory, there's another major issue most have overlooked.
Under current arrangements governing KiwiSaver, people are enrolled into one of six government-appointed "default" schemes if they or their employer don't make a choice.
And within those default schemes they are, by default, put into "conservative" funds.
These conservative funds comprise primarily low-risk, low-return assets such as fixed interest products, term deposits, and government bonds. That's a good investment strategy if your saving horizon is only a few years and you don't want to risk the short-term fluctuations associated with assets with higher expected returns.
But over the medium to longer term, which is what most retirement savings plans should be, conservative funds can disadvantage the saver.
Research by ANZ Wealth estimates that about 191,000 New Zealanders stand not to make upwards of $72,000 each by the time they retire in 40 years' time. That's a nationwide shortfall of about $14 billion.
In an ideal world, people should get advice on investing and saving, including for their retirement. The truth is most New Zealanders can't justify paying for advice and are relying on this "double default" approach.
If this is the case, then policymakers need to take a pragmatic approach to the framework for KiwiSaver.
The facts speak for themselves. Over the past 40 years, through periods of huge change and market volatility, growth assets have outperformed defensive low-risk assets.
New Zealand shares have returned 10.8 per cent a year, global shares (hedged into NZD) 9.4 per cent, whereas New Zealand bonds have returned 8.17 per cent. The Credit Suisse Yearbook 2011 says research shows that over the period 1900-2010, equities outperformed bonds by an average of 3.8 per cent a year across 19 countries.
It's important when investing that people take the emotion out and look at the numbers.
ANZ Wealth developed a case study based on robust modelling and analysis. This showed that a 25-year-old, starting their working life earning the average wage of $36,000 a year and putting in the current minimum contribution of 2 per cent of salary (matched by employer contributions and assuming annual wage increases based on inflation and increases in their skills), will have saved about $248,000 via a conservative fund when they retire at 65.
But if they'd invested using what we call the Lifetimes Option (sometimes referred to in the industry as a "life stages" approach to investment), where investment allocations change according to their age and risk profile, then we calculate expected savings of about $320,000.
This strategy recognises that as an investor nears retirement their investments should be gradually moved to lower risk, conservative assets. It's worth noting that the current review of "My Super" in Australia also endorses a "life times" approach.
In recent years, with the global financial crisis, conservative funds have done well. This is not an argument for conservative funds because it's important to remember that the investment horizon for young KiwiSaver investors is 30 to 40 years, not three or four.
There is also the danger that young investors in higher-risk, longer-term investments might get unnerved by short-term ups and downs in their KiwiSaver accounts and stop saving after a while. But that is an argument for better investment education and not a reason to stay in conservative funds forever.
Of course, like all simple arguments, there is an exception to the rule. Investors under 35 might be saving for a deposit on their first home, before they start saving for retirement. In which case, they would be best placed investing in a conservative fund.
With all these considerations in mind, our research still shows the potential for better outcomes over a 40-year period when using a "life times" approach to investment. That's why we're calling for a change to the default investment option for default KiwiSaver schemes. If we don't make this simple adjustment, it will cost the country billions of dollars in savings and compromise the standard of living of a generation of retirees.
People often complain that New Zealand's equities market lacks sufficient local investment. That's been one of the arguments used for partial floats of state-owned enterprises. This change to KiwiSaver would help address that problem, too.
What makes this issue all the more urgent is that the potential victims think everything's okay. Thousands of 20- and 30-something people have done the right thing and joined KiwiSaver. They've made the smart commitment to save directly from their pay for the rest of their working lives, and they're probably thinking they've got one less thing to worry about. Potentially, these people are going to be short-changed and they don't even know it.
It's encouraging that Revenue Minister Peter Dunne recognises this and will look at the issue as part of the overall review of KiwiSaver.