Many New Zealanders are not on-track for a comfortable retirement. As a nation, we are simply not saving enough. And the small amount we are saving is not being invested for long-term wealth creation.
To begin, let's consider how much money you need to fund a comfortable retirement.
Massey University and Westpac conduct a regular retirement survey that shows if a couple wants to enjoy its version of a Metro Choices lifestyle, they need $486,000 (if they are retiring today) to supplement their NZ Super. If they were to retire in 20 years, after inflation, the amount needed jumps to $725,000. However, a more detailed analysis shows that this may be understating what a true Choices retirement looks like. For example, the survey data appears to only allow a couple to have one modestly priced meal out per week and does not allow much for travel - even smaller trips within New Zealand. After adjusting for these types of expenditures, we would argue a true Choices retirement - what we're calling a Choices Plus retirement - requires a couple to have about $630,000 if they were to retire today and about $940,000 if they were to retire in 20 years.
However, Stats NZ data shows the median New Zealand household currently has about $62,000 in financial assets. Assuming 20 years until retirement, we estimate this household needs to save at least 11 per cent of their income every year and invest it in growth assets to reach a Choices retirement. If they want a Choices Plus retirement, they'd need to save at least 17 per cent of their income. This is a far cry from the 3 per cent employer and employee KiwiSaver contributions many investors are currently making.
It's worth noting two critical assumptions here; First, investments have a real return of 5 per cent per annum during retirement and households consume all their liquid savings in retirement. Any change in these assumptions has a material impact on the savings required. For example, if you invested your retirement savings in term deposits and only received a return around the inflation rate, the lump sum you need would be more than 40 per cent higher.
So how much are we currently saving? Well, despite strong economic conditions New Zealand's household savings rate has actually been negative the past few years. This contrasts with positive savings rates of about 4.6 per cent for Australia and 5 per cent for the USA and Europe. This means in aggregate New Zealand households are spending more than they are earning.
The data paints a concerning picture. Although many Kiwis aspire to a higher quality retirement, they are not on-track to achieving it.
A formal review of the savings situation in New Zealand needs to be undertaken with the Government prioritising measures to lift our household savings and encourage productive investing. This report should include a clear statement on the sustainability of NZ Super. The public needs to know how much Super they will have so they can plan accordingly.
Before he became Finance Minister, Grant Robertson said he wanted KiwiSaver minimum contribution rates lifted from 3 per cent to 4.5 per cent. The problem here is many Kiwis are already very stretched financially and cannot afford to contribute more.
A more effective approach is to incentivise people to save more. For example, having KiwiSaver contributions (up to an annual cap) come from your pre-tax income, with any extra contributions not receiving the tax incentive. Another option is to reduce the tax rates on investment earnings in KiwiSaver funds. Therefore, allowing investors' money to grow and compound faster than it does currently. Either option would encourage additional savings and particularly benefit lower and middle-income earners. The status quo is not working, as evidenced by the fact anyone earning over $35,000 per annum currently has no tax incentive to save more than 3 per cent to their KiwiSaver account. Australia, the US, the UK and Canada all have stronger forms of tax incentives to encourage retirement savings - and all these countries have higher savings rates than New Zealand.
Making matters worse, the small amount we are saving is being invested too conservatively. In large part because young KiwiSaver members who do not actively choose their fund are defaulted to a conservative fund. Eighty one per cent of KiwiSaver members have 10-plus years until retirement, yet just 32 per cent of KiwiSaver money is in growth-oriented funds. This is a huge mismatch because growth funds should deliver better returns than conservative funds over longer time periods.
For example, the average KiwiSaver default fund, which is primarily invested conservatively in bonds and cash, delivered a return of 5.4 per cent per year over the first 10 years of KiwiSaver. While the average KiwiSaver growth fund delivered 6.7 per cent per year. Project these returns forward and an average 25-year-old investor would be more than $200,000 better off at retirement simply by choosing a growth fund over a default fund. And the better performing KiwiSaver growth funds have done even better, with the top quartile of managers delivering 8.5 per cent per year.
Having a conservative fund as the KiwiSaver default fund is akin to giving our community poor investment advice. And in this case the poor advice is coming from the Government and it's costing Kiwis hundreds of thousands of dollars in their retirements.
We can, and should, have comfortable retirements, funded by effective saving and smart investing. New Zealanders deserve no less.
Troy Swann is CEO of Milford Asset Management.