Beating the rate of return

This is a great article by Martin Hawes which explains why the key driver for accumulating retirement funds is the level of savings.

The savings rate nearly always beats the investment rate. This basic rule of personal finance effectively says that you are likely to end up with greater wealth if you can save more rather than find a higher rate of investment return.

It means someone who budgets and puts more aside will usually beat the investor who hunts out a higher return.

This idea is one of my basic financial planning principles and, in most circumstances, I encourage people to save as much as they reasonably can, although, obviously enough, I do not ignore good returns either!

This high savings rate is one of the reasons KiwiSaver is working so well. Many people are starting to see quite significant balances in their accounts. Kiwisaver accounts have been getting very good returns in the past five years or so, but this is not the main reason for growing funds.

The real reason for the high balances is the amount that is being contributed. You put in 3 per cent of salary, your employer also puts in 3 per cent and on top of that the Government chimes in with the Member Tax Credit ($520 p.a.)

Add it up and for many people that is a lot of savings – and the good investment returns that we have had in recent years put the icing on a nice, big cake.

Given that the biggest factor for the ultimate size of your KiwiSaver is the amount of your contributions, a question arises: should you add more? Why not put in 4 per cent or even 8 per cent or more? In fact, if you received a lump sum (e.g. an inheritance) why not put that in?

Well, if you added more you would certainly end up with a much greater amount. Although any amounts over 3 per cent of your salary probably will not attract any further employer subsidy, you can, if you want, add more.

The big problem with adding more than the amount to attract maximum subsidies (usually 3 per cent of salary) is that you would be unable to withdraw the additional contributions if that became necessary.

KiwiSaver accounts can only be cashed up for the purchase of your first home or on retirement. There are a few other extraordinary circumstances that allow you to get at your KiwiSaver funds (e.g. bad health or financial hardship), but these are not things that you want to plan for.

This lack of KiwiSaver liquidity means standard advice from most financial advisers is that you only contribute sufficient to receive maximum employer subsidies. Then, for any further money that you have spare, open another investment account. This new investment account that you open would be liquid – i.e. if the need arose you could draw on your funds at any time

However, there are some circumstances which could mean that do not follow standard advice and you add more than the usual amount:

  • You are using your KiwiSaver account to save for your first home.
  • You are within a few years of retirement age – i.e. funds are able to be drawn quite soon.
  • You want to access some particular kind of investment account which is not available outside of the KiwiSaver scheme.
  • You lack discipline and do not trust yourself to keep your hands off another more liquid investment account.
  • You judge that you are most unlikely to need your KiwiSaver funds before retirement age.

To get ahead financially you do need to save as much as you can. KiwiSaver might be a suitable savings vehicle for a relatively small amount of your additional savings especially if you find the array of other, alternative funds confusing to the point of inertia.

Remember also that the fees on KiwiSaver are often lower than other comparable funds. Generally, using KiwiSaver as an all-purpose savings vehicle is not the right thing to do, but I would rather see a client save through KiwiSaver than not save at all.

Sunday Star Times 24 April 2016 Martin Hawes