This article was published on 19 June 2010. Some information may be out of date.

Too good to be true — but it is true

It sounds like a too good to be true scheme that’s bound to end in tears: “Earn 36 to 56 per cent a year on a low-risk investment!” But there is such an investment, and it’s called KiwiSaver.

I should say upfront that those returns apply to your first five years in KiwiSaver. While people who join over 60 get only five years of full participation, others will take part for considerably longer. And the longer you contribute, the less spectacular the returns. But they still easily beat alternative investments of similar risk.

The reason, of course, is that the government and often employers contribute to KiwiSaver. And when we look at returns, we look at total growth in your account relative to how much you put in — not total contributions.

Some say that’s cheating. But if you compare KiwiSaver with, say, rental property, shares or term deposits, you would have only your own contributions to those. If you’re looking at how well you can do with a given amount of savings, this is the only way to do it.

Let’s consider first the five-year KiwiSaver returns. We assume you invest in a fund that earns 3 per cent a year after fees and taxes — a likely return on a low-risk fund that invests in bank term deposits, government bonds and the like. For employees we also assume you contribute 2 per cent of your pay, which grows by 3 per cent a year — although if it grew more slowly that would make little difference.

  • Over five years, an employee earning $25,000 would put about $2660 into their account, which would grow to $9700. To get that much growth elsewhere on the same contributions, you would need a return of a massive 56 per cent a year.
  • An employee on $50,000 would contribute $5310, and the account would grow to $18,100 — equivalent to 53 per cent elsewhere.
  • An employee on $100,000 would contribute $10,620, and the account would grow to $29,500 — equivalent to 44 per cent elsewhere.
  • A non-employee contributing $20 a week or $87 a month — to get the maximum tax credit — would contribute $5220, and the account would grow to $12,200. That’s equivalent to 36 per cent elsewhere.

It’s “the impossible”: really high returns for low risk.

What about people who are in KiwiSaver for longer? To understand why they get lower average returns, we need to look at each year’s contributions to KiwiSaver.

Assuming a 20-year-old doesn’t make a withdrawal for a first home — which would complicate our story — her first contribution will probably be in KiwiSaver for 45 years.

Her own deposit will be boosted by the $1000 kick-start, the tax credit and perhaps an employer contribution. So in the first year the return on her money will be several hundred per cent. Wow! After that, though, that first year’s money sits in the account for another 44 years, earning in our example just 3 per cent.

In the second and later years, her contributions continue to be boosted by tax credits and employer contributions. But then that money, too, earns just 3 per cent, for 43 or 42 or 41 years, and so on. The long years of ordinary returns water down the effect of the huge first-year return. And the younger the person, the more the watering down.

Nevertheless, the initial turbocharging of each contribution is still powerful. Put it this way: year after year, KiwiSavers’ contributions are at least doubled and in some cases trebled. And double or triple the money going in means double or triple coming out again. That’s hard to beat.

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.