This article was published on 4 May 2019. Some information may be out of date.

QI recently looked at my latest KiwiSaver update.

I am with a provider (in an active growth fund) that has won a few awards and consistently advertise that they have the best long-term returns.

As part of this update, they provide returns across a raft of time periods as well as compare with key indexes.

Interestingly, the S&P/NZX 50 Gross Index has outperformed this fund in the short and long term. Is this surprising?

Given my KiwiSaver provider has consistently received awards for their performance, I am surprised and disappointed that most funds would be delivering less than an index fund.

AIt’s great — at least in principle — to see KiwiSaver providers showing their investors how well they have performed compared to an index.

In active growth funds like yours, the managers choose which investments to buy and sell. Comparison with an index tells you whether your fund grew or fell because of the managers’ decisions or whether it was just because the whole share market rose or fell.

But your letter raises an important issue: Is the right index — in this case one that measures how well the biggest 50 New Zealand shares have performed — being used? Or, indeed, is there any suitable index?

There are a few worries:

  • The fund won’t be investing only in shares. The KiwiSaver Fund Finder on defines growth funds as those with 63 to 90 per cent of their investments in “growth assets”. Usually the growth assets are shares, but sometimes they include property. And obviously growth funds also have between 10 and 37 per cent of their money in non-growth assets — commonly bonds but perhaps also cash and other assets.
  • Some KiwiSaver funds with “growth” in their name make a practice of moving a chunk of their investments out of shares and into bonds when they think the share markets are going to fall, and back when they expect a rise. Sometimes they get that market timing right, sometimes not. When they move out of shares, they are no longer growth funds by the Sorted definition. And, of course, a comparison with a share index is even less appropriate.
  • The shareholdings in KiwiSaver funds almost always include international shares as well as local ones. But your fund is being compared with NZ shares only. And as it happens, local shares have had a particularly good run in recent years. As I said last week, the S&P/NZX 50 Gross Index increased almost four-fold over the last ten years.

But NZ shares don’t always do so well. Let’s look at a list of the world’s biggest sharemarkets — Canada, China, France, Germany, India, Italy, Japan, UK and US — plus Australia and New Zealand. Since 1985, local shares have been the best performer in three years, but the worst performer in three other years.

It’s wise for KiwiSaver funds to invest beyond this country. But it makes comparison with an NZ sharemarket index a bit confusing.

All in all, we’re far from comparing apples with apples here. It’s more like apples with exotic fruit salad, plus some ice cream to represent the assets other than shares.

Ready for another complication? The returns you’ve been given are after fees. That makes it hard for your fund to beat an index — which doesn’t allow for fees.

Still, I’m never surprised when an active fund doesn’t perform as well as an index fund — which invests in the shares in a market index. Index funds are much cheaper to run, so their fees are often much lower, giving them a considerable advantage over active funds.

QI was watching a YouTube from, based in the USA. He was saying that after 13.4 years your investment is making more than you are investing!

I presume that’s the same for any share investment? But most people including me didn’t know this. Can you explain how it works?

AWhat the guy in the video is pointing out is that, once your savings have become reasonably big, even a fairly modest return adds big dollars.

For example, early on your savings might total just $1000. If you get a 7 per cent return, the total grows by only $70. But some years down the track, your savings total $10,000, and the same 7 per cent return will grow your savings by $700.

The guy compares these return numbers with the regular contributions you are making to your savings — in schemes like KiwiSaver.

At the start you might be putting in $400 a year. That dwarfs the $70 growth in your savings. But then he assumes your contributions grow by 2 per cent a year as your wages increase, but your savings are growing by 7 per cent — much faster.

In the particular example he uses, after 13.4 years the return — the growth in your savings — is bigger than your contribution. And after another 10 years, the return is twice as big as your contribution. But under different assumptions, those periods would be different. There’s nothing magical about 13.4, even though it sounds a bit magical!

The main point is that compounding growth seems slow at first, but it gets more and more powerful. So it’s a great idea to start saving — or investing — as soon as possible.

Would this work with a share investment? The guy assumes steady returns of 7 per cent a year. In the real world, in a share investment or KiwiSaver or pretty much any investment riskier than a bank term deposit, returns wobble around. In shares or a fund holding lots of shares there will be some years when the return is negative.

Still, over time your returns will exceed your regular contributions — and by a bigger and bigger margin, really boosting your savings. His point is a fair one.

QAs new parents in our early 30s, we are considering setting up a long-term investment fund for our child’s (and her siblings’) future.

We’re also about to buy our first family home, so will have a sizeable mortgage to pay off over the next couple of decades.

I am wondering whether we should focus solely on paying off our mortgage in the hope that by the time we are wanting to pass on funds to our children we are largely mortgage-free, or if we should start a separate growth investment fund now, which we contribute to quietly (e.g. $100 a month) over the same course of time as our mortgage?

I note a long-term growth fund will likely have higher returns than our mortgage, with the current low interest rates.

AYou’re analyzing it properly — comparing the return you’re likely to make on an investment with the interest rate on your mortgage. That’s because paying off a mortgage or any other debt that charges X per cent interest improves your wealth in the same way as an investment that pays you X per cent.

And yes, a growth fund, which will usually invest largely in shares, is highly likely to bring in an average long-term return that’s above mortgage interest rates.

It will be volatile though. You have to be prepared for long periods when your balance is falling. Never withdraw the money or move to a lower-risk fund at such a time. People who do that, making their losses on paper into real losses, end up as losers.

It’s because of this tendency to panic in falling markets that I generally recommend reducing a mortgage rather than investing.

You could respond by saying, “Okay, I’ll avoid big volatility by investing in a lower-risk fund.” The trouble is your return in such a fund is likely to be lower than the mortgage interest rate, so mortgage reduction is better.

But if you can promise yourself that you will stick to the high-risk investment through thick and thin, it should work well. After all, you’re not contributing a huge amount. And you’ll be learning how markets behave over the decades — good preparation for when you pay off the mortgage and get into serious saving for retirement. That must seem a long way off for you, but it does happen!

Footnote: I assume you’re not thinking of investing this money in KiwiSaver because you may want access to it before you are 65.

But anyone weighing up investing versus paying off a mortgage should keep investing in KiwiSaver. Most people should contribute only enough to get the government and — if applicable — employer contributions. Unless you can easily cope with the volatility of a higher-risk KiwiSaver fund, it’s best to put further savings into cutting down the mortgage.

QI thought your advice last week to the mid-50s couple with so many eggs in the property basket was spot on.

In 2014, we sold our house in California. We’d bought it in 1990 for $385,000 and sold it 24 years later for $1.9 million. This, we thought, was a fabulous capital gain. Not necessarily so, said our financial adviser — though we all agree we did need somewhere to live during these years.

We were doing some portfolio balancing at the time, so she ran a few Monte Carlo simulations to see how that $385,000 might have fared other than as an investment in a house. The no-risk and extreme-risk investment options showed (predictably) that the house would have done — correspondingly — better and worse.

But most telling: in a well diversified portfolio with medium risk, we would have done better with the basket of stocks and bonds, even in spite of the stock market gyrations that occurred over those years.

APeople looking at house price rises often don’t realise how fairly ordinary returns can add up to big gains over long periods, because of compound interest.

In your example, the value of your house grew by almost 7 per cent a year — as shown by an online lump sum calculator. That’s not bad, but it’s hardly fabulous.

As you point out, though, you did get accommodation through the period as well. If you had put the money in other investments, you would have had to pay rent. By the time we take that into account, you did pretty well with that house.

QLast week’s correspondent who had problems joining ASB Kiwisaver at age 64 must have been very unlucky!

Ten years ago, at age 64, my wife and I sold our family home and decided to rent for six months while looking for a smaller easy-care unit. I approached ASB for advice on what to do with the proceeds of our house sale for the six months.

A very nice personal banker solved that “problem” and asked if I was in KiwiSaver, I replied no. She promptly urged me to join. I did it on the spot in ten minutes.

Turned out to be a great move. Even now I still contribute $40 a week and have an automatic withdrawal — $500 per quarter to coincide with my rates bill.

So I put in, roughly speaking, $2000 a year and withdraw the same, yet it still grows at a faster rate than any savings account! From a happy long-term ASB customer.

AYou win some, you lose some. I did get one other letter from another reader saying she had similar problems to last week’s correspondent, so obviously ASB’s service is variable. But it’s great you were served so well.

No paywalls or ads — just generous people like you. All Kiwis deserve accurate, unbiased financial guidance. So let’s keep it free. Can you help? Every bit makes a difference.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.