NZ Herald 1 September 2007

AI’ve not heard of any finance company offering KiwiSaver, and I would be surprised if they do in the current climate — although who knows what the future might hold? But most KiwiSaver providers are entirely different creatures from finance companies.

Over in one corner we have a finance company, which is basically like a bank. People invest their money in it in much the same way as with bank term deposits. And the finance company lends out that money in much the same way as a bank does.

The big difference is risk. Anyone with any smarts who wants to borrow money — whether it’s for property development or to buy a used car — will go first to a bank, because banks charge the lowest interest.

However, despite the fact that banks in recent years have been keen lenders, there are some people and projects they won’t lend to. The banks are not confident that they will be repaid and, if they are not repaid, that the security on the loan — perhaps an as yet unbuilt building or a used car — will be worth as much as the loan in a mortgagee sale or repossession.

If the banks say “No”, the borrower then goes to a finance company, which is willing to take on the higher risk, but only if it gets a higher return to compensate. So it charges higher interest.

With the finance company earning higher interest than banks on the money it lends out, it can afford to pay higher interest to depositors. Hence the attraction for many investors.

As investors are increasingly understanding, though, some of those property developers and used car buyers don’t end up repaying their loans. And, sure enough, their security doesn’t cover the debt. The money just isn’t there to give back to the investors at maturity.

Over in the other corner, we have a typical company that offers KiwiSaver. While some banks are KiwiSaver providers, the provider part of their business does not operate like a bank.

The typical provider doesn’t lend money. It uses investors’ deposits to buy bonds, shares and so on.

Some KiwiSaver members, who are conservative and/or expect to be spending the money in less than ten years, will go into a KiwiSaver fund that invests mainly in bonds and what’s called cash — government and bank on-call or short-term deposits — generally 90 days or less.

Because the KiwiSaver fund pools many people’s money, it can buy and sell these investments on better terms than you or I could, and it can get a wide spread of investments. If one or a few collapse, that won’t be disastrous.

It would be unusual for investors’ money in such a fund not to grow pretty steadily.

In a less conservative KiwiSaver fund, which invests mainly in shares and perhaps commercial property, growth will depend on what happens in the share and property markets. Often, investors’ balances will go down. And if there’s a market crash, they will go way down.

But people should be in these funds only if they have a long time horizon and are willing to stay through the downturns. The markets always recover and grow again.

Over a decade or more investors in these funds will almost always do better than in more conservative funds. And particularly over long periods, investors tend to do very well.

But if you can’t stomach ups and downs, stick with a conservative fund.

Another point: Finance companies, like banks, are susceptible to “runs”. If there’s a crisis of confidence, many people want their money out at once. But they can’t all get it, because most of it is lent out. That’s led to the downfall of several finance companies recently.

I’m not saying that a typical KiwiSaver provider would cope easily with many members’ wanting to move their money to a different provider. They would have to sell some investments in a hurry, and so they may not get very good prices.

Basically, though, the assets are there to back up members’ investments. You don’t get the same “run on the bank” effect.

So how do you pick a safe KiwiSaver fund? There are no magic answers, but read on.

AI guess anything could happen.

But do we keep our money under the mattress because the bank could fail? Do we refuse to insure our homes and possessions because the insurance company might not pay up? Do we not drive because, no matter how careful we are, some idiot might drive into us?

Life is full of calculated risks. If you don’t want to use a bank or insurance or a car, fair enough. But most people would argue that you lose more than you gain. Ditto KiwiSaver.

Your contract idea couldn’t work. Firstly, even business contracts routinely have clauses to allow for change. Also, a government is the body that makes the laws that govern contracts. Any future government could make changes that make a current contract null and void.

Nobody can bind a future government to anything. And — when you think of what past governments have sometimes done — thank goodness for that.

There are, however, protections for KiwiSavers. While it’s quite possible that future politicians could reduce incentives, anyone who doesn’t like that can simply stop contributing any time after a year in the scheme.

I suppose, theoretically, politicians could also claim back your kick-start and tax credits already earned, or make it harder to get your money out. But how long would they stay in office? I just can’t imagine that in a democracy.

What about the danger of a fund provider “failing”? There are no guarantees. But if you go with a reputable company, it’s unlikely.

The government actuary and fund trustees will be monitoring KiwiSaver providers, and the media will take an interest. If you hear anything iffy about your provider, you can readily move to another one. You’re not stuck there like finance company investors, waiting for your debenture to mature.

In the end, though, if you are still too scared, by all means sit on the sidelines and watch many other New Zealanders building their wealth.

By the way, my support for KiwiSaver is far from unqualified. It’s probably a bad use of taxpayer money. It was introduced way too fast and is therefore much too complicated. It ties up people’s money — and therefore everyone except those with a willpower problem should contribute as little as necessary to get the full tax credit.

Despite all this, everyone under 65 stands to gain by being in KiwiSaver. While I don’t want to upset you, I hope your children do join.