How to choose a KiwiSaver fund Part One The Conservative Fund deconstructed
Recently we released our first fund updates showing our performance and ranking it against our peers.
We were pleased to have been ranked second place for our flagship growth fund which returned 1.9% (after fees) in the quarter ending Dec.31, 2016. Our Balanced fund was around industry average and our Conservative Fund negative 1.5%.
Members of the Growth fund may have been cheering the results, members of the Conservative fund frowning.
Despair not because short-term performance in a long-term savings vehicle such as KiwiSaver can be fleeting.
Regardless of what fund you are invested in, there will be cycles in the markets that drive good years, and bad years. Over-time, history shows they trend up, albeit some funds climb higher and faster than others.
It's important to understand the expected returns and performance of the various funds and the factors that influence returns.
So let's start with the Conservative Fund and how that differs from our other two funds on offer.
If you look at the pie chart below you'll see a breakdown of the asset allocation.
The fund is comprised of approximately 34% in NZ fixed interest (bonds), 44% international fixed interest, 10% international shares, and another 7% of Australasian shares, split equally between NZ and Australia. This division is merely a target and what's actually in the fund will change from time to time but not significantly.
In the most recent quarter we held 2% of the fund in cash.
The reason for this has to do with our investment philosophy. It's our belief that over time, fixed interest will see investors better off than a higher weighting of cash. That's normally the case but with the bond market having one of the worst periods in five years, that wasn't reflected in the most recent quarter.
We don't believe this is a reason to switch, if being in a conservative fund, is the most appropriate for you. Again, short-term performance marks a very short period of time. If there was a sustained period of negative returns of course we'd re-evaluate our position, but studies have confirmed our view that bonds will outperform cash over time.
As you know though, returns from shares swing around more than the returns from bonds and the return on cash is stable. That is why more risk averse investors will tend to hold more bonds and cash.
What about equities? Our allocation in the Conservative fund is relatively small because of the volatility associated with investing in equities. Because many investors attracted to Conservative Funds are risk averse, and prefer more certainty around their returns over the long-term, managers try to minimise the risks. The downside for investors, is that with a smaller exposure to this asset class they lose out on potentially higher long-term returns.
History shows us that over the long term, returns from shares are higher than the returns from bonds, which are higher than the returns from cash. KiwiSaver is a long term investment and so we rely on these historical relationships.
Most of our members are contributing regularly. If and when share markets fall, members will be buying units at lower prices and the average cost of the portfolio reduces too. By the time members reach retirement, we are confident prices will have risen again and those who continue to contribute through both good and bad times will be the ones who benefit the most.
What doesn't Simplicity have a 100% cash fund?
We get that question periodically.
The problem with cash only is that by the time you take account of fees and inflation, there is not a lot left for investors. We believe our members are better served in funds that are well diversified and deliver strong longterm results. All of our funds have more than 9,000 investments spread across 23 countries, to minimise risk from too much exposure to a single asset class, company or country.
The bigger question for investors should be whether they are in the right fund for the right reasons, assuming they understand the difference between each fund.
So let's have a look at some of the considerations around a decision to invest in the Conservative Fund.
One of the main reasons people choose Conservative over another fund is risk. As you'll see on the Fund Update report here, the risk of this particular fund is rate 3 out of a possible 7. The rating reflects how much the value of the fund’s assets goes up and down.
A higher risk generally means higher potential returns over time, but more ups and downs along the way.
If you're someone who can't bear the thought of losing money and gasps at the volatility of the fund as the market moves up and down, a Conservative fund is a friendly investment. And yet it's important to remember even Conservative Funds are not risk free or volatility free as this recent quarter’s performance demonstrates.
A 100% cash fund is not offered by Simplicity and even if it was, the returns with interest rates at historical lows, wouldn't generate much in the way of a return to combat tax and the effect of fees. Fortunately, with Simplicity the fees being the lowest in the market help to keep the performance of our diversified fund healthy over time.
Knowing your own attitude to risk, as well as understanding what you are invested in, can reduce investor shock and or stress.
There are some helpful tools on Sorted.org.nz to help you both these.
Another consideration when choosing a fund is your time frame for investing. In many cases, people choose to be in a Conservative fund because they don't expect to be invested for more than five years. That would be the case with someone wanting to withdraw their money for a first home deposit or perhaps someone over 60 who expects to draw down their savings at the age of eligibility.
An exception here would be someone over 60 who wants to keep their money invested past age 65 and draw down gradually, which you can do with Simplicity’s KiwiSaver scheme. Depending on a number of factors, again risk tolerance, financial need health, and goals, a higher returning fund might also be appropriate. It very much depends on one's circumstances and one size does not fit all.
Questions to ask
If you are reflecting on the type of fund that is best suited to you, some questions to ask:
What's your purpose of being in KiwiSaver: Retirement or First Home Deposit savings?
Do you understand the various risk and returns expectations with each fund?
How much are you expected to need in retirement or for that first home and which fund can best target that goal?
One of the many great features of being a member with Simplicity is that you can change funds without penalty. It's easily done through the web app once you are a member.
Simplicity also has tools for showing you how much you can expect to earn over a period of time, across the various funds, giving you the ability to plan better for your future.
We like to these because they are easy to use and get people excited about financial planning and retirement instead of feeling disconnected from their money and confused about the fund management sector.
For more information and a guide to our member's website functionality, check out this tutorial here.
Next week in Part 2, we'll take a closer look at the Balanced fund.
Amanda and the Team at Simplicity %)