Kiwis choose their KiwiSaver funds badly. I can say that with hand on heart knowing that 23 per cent of us were allocated to conservative funds by default. Still more are in conservative funds at a young age when they should be taking more risk in return for growth.
Ask questions of those around you and their reasons for choosing their KiwiSaver provider may not be robust. "I'm with my bank" is a common one.
Choosing the wrong fund can cost tens or even hundreds of thousands of dollars over a lifetime. Some of the mistakes KiwiSavers make when choosing or switching funds include:
Making judgments over too short a periodThe point of KiwiSaver is that it's for retirement. That might be decades away. Judging KiwiSaver returns on three months or a year is totally pointless.
"The initial short-term outperformance of conservative funds is a good example of how short-term past performance is not a good guide to future performance," says Vedran Babic, operations manager at Fisher Funds. Although conservative funds were the top performers for the first few years of KiwiSaver, which encompassed the global financial crisis, some growth funds have doubled members' money since.
Buying on last year's performanceThere is nothing wrong with lists of top-performing KiwiSaver funds. They shouldn't be taken in isolation, however. Last year could have been a really good year for the type of investments in those funds.
Perhaps the most extreme example of this was the Huljich KiwiSaver scandal. Huljich Wealth Management set up one of the early KiwiSaver funds and marketed itself as a leader with stellar returns. Anyone who had invested on the apparent returns was being misled. What was happening in the background was that director Peter Huljich was paying his own money into the KiwiSaver scheme to top it up and cover up poor investment decisions.
This is a bit of an extreme example because the law was broken. However, it shows that good results aren't always what they appear.
Another reason that last year's performance is not always an accurate predictor of the future is that there can be a degree of luck or timing over and above investing prowess.
Some of the better-performing KiwiSaver funds in recent years, says authorised financial adviser Jeff Matthews, have had a higher proportion of their equity investments in New Zealand and Australia than international markets, which haven't performed as well. That could turn around and the schemes that have a broader international mix could overtake their counterparts.
What's more, fund managers who make the investment decisions can and do leave. Brook Asset Management, a boutique investment firm, was once the darling of private investors. The brains behind its early success included fund managers and analysts Mark Brighouse, Paul Glass and Simon Botherway who, as happens in business, moved on.
That's not to say that the new team isn't just as good - in fact, Brook's Growth KiwiSaver fund is in fourth of nine places in Morningstar's rankings for aggressive KiwiSaver funds over five years. The point is that investors who wanted the investing styles of Glass, Botherway and Brighouse would need to follow them to their new funds.
Fund quarterly and annual reports will tell you who the key people behind the investments are. I noticed with my KiwiSaver fund that one of the two key people making investment decisions had only been in his current position for four months. What's more, the pair managed both the growth fund and the conservative fund. Herald writer Brian Gaynor disapproved of this approach in his column last week. Gaynor argues that different skills are needed for each. Read the article here: tinyurl.com/GaynorKiwisaver
As well as rankings, star ratings are too general to make decisions on - although they might help differentiate between two similar funds. Morningstar's star ratings, for example, calculate the risk penalty into returns, but don't capture all the factors that might be important for a KiwiSaver investor.
Defaulting into conservative fundsConservative funds are good for some people, but too many investors are in them because they didn't make a choice. The average default fund has returned 5.7 per cent over five years and growth funds 6.7 per cent, according to Morningstar. That smallish difference really starts to add up over time as returns compound. The Financial Services Council crunched the numbers and worked out that average Kiwis who default into conservative funds, contribute 6 per cent of wages and remain there for 40 years could lose as much as $250,000 compared to investing in a growth fund for that time.
Private investors often have no idea what their risk tolerance is, says Matthews. They may be invested in a growth fund, but would leap if there was a 15 per cent drop. Or, as many are, they're in a conservative fund, but have the stomach for the ups and downs that come with superior growth.
Buying on the manager's claims aloneKiwiSaver providers are in business to make money for themselves. While it's in their interest to do well to get more customers, they still get paid by you whether or not they are good at investing your money.
Every manager finds ways to make his funds look like a winner, even if they're not.
I checked this week and the lowest performing balanced fund over five years in Morningstar's latest rating was the Smartkiwi Balanced Fund. I don't expect NZX, which owns it, to broadcast that this fund came last, but anyone who only read the marketing material wouldn't know that. It's very easy to brush over a history of poor performance with marketing language or convenient unscientific statistical comparisons.
The marketing material for the Smartkiwi Balanced Fund talks about delivering "best value from your money" and "a clear and simple investment choice". The website goes on to say: "We believe you should get the most out of your savings and this is our goal in all aspects of our scheme". For the record, Smartkiwi Conservative Fund was second in its field.
Failure to ensure diversificationAs KiwiSaver funds grow, the issue of proper diversification is going to become more important. At the moment it's only ever possible to have money in one KiwiSaver fund with one manager. That means potentially that some people could have hundreds of thousands of dollars invested in a single fund - albeit with many underlying holdings - and no other investments. Diversification within KiwiSaver funds is going to become more and more important.
Some investors have chosen single-sector KiwiSaver funds such as Australasian property funds, which means they're exposed to a slump in that one small market. Even multi-sector KiwiSaver funds often have a leaning towards one type of investment or another.
Looking at the growth fund I'm invested in, only one of the top 10 investments isn't Australasian equities or listed property. That might be important for some investors.
What some people do without realising is duplicate investments - or have everything in the same markets. They might, for example, have direct shareholdings in some of the top 10 investments of their KiwiSaver fund. Or they might have other funds that concentrate on the same markets.
Matthews had one client who, for historical reasons, held four UK-based investment trust funds when she came to him. Each had many of the same investments, which meant that she wasn't anywhere near as diversified as she thought.
Not knowing what's under the bonnetMany KiwiSavers have no idea what's under the bonnet. Ask the person next to you if he or she can tell you what percentage of their KiwiSaver money is invested in shares. I wouldn't mind betting that many of those who are in the default funds would say "none", yet these funds must have 15 per cent to 25 per cent in growth assets.
The Mercer Conservative Fund, a default fund, has 15.57 per cent invested in shares and just over 2 per cent in property.