Why Kiwisaver Won’t Cover Your Retirement

Kiwisaver is unlikely to cover the cost of your retirement. But it’s very likely to cover the retirements of Kiwisaver providers, fund managers, bankers, accountants, lawyers, public servants and everyone else connected to the growing Kiwisaver industry.

Before I discuss the specifics of Kiwisaver, I’m going to share with you the basic maths of retirement. Like an economist, I’m going to build a basic model that ignores the real world and makes some simplistic assumptions. I’ll then share with you why this standard model of retirement is extremely risky.

The basic model goes like this:

  • You work from age 25 to age 65
  • You earn the median income ($560 / week) for that entire period with 4 weeks off.
  • You contribute 2% to Kiwisaver with your employer matching that
  • The Sorted.org.nz calculator assumptions apply

Selection_068This is where the fun begins and I can destroy the silly assumptions made by this model, upon which most people are planning their retirements. What is scary is that I chose the median income – 48 weeks a year @ $560 a week. That’s just $27k a year and 50% of the population earn less than that and probably can’t even manage the 2% Kiwisaver contribution.

Furthermore, I am assuming a regular income. There is no option for people who can’t get full time hours or anything more than a string of casualised positions. How will they accumulate any sort of Kiwisaver account balance that can help them in old age?

The next hurdle is the option that Kiwisaver has to withdraw your account balance to put a deposit on a house. Putting aside the reality that buying is almost always a worse idea than renting, how many people who take money out of their Kiwisaver accounts will start their contributions back up again?

Again, once they have sacrificed their retirement on the altar of home ownership, exposing themselves to the risk of negative equity and working as a debt slave for an Australian bank, will they ever be in a position to “save” again?

It’s unlikely. That’s because the standard models forget about something stock standard in the modern New Zealand lifepath. Divorce! Separation! This means that many people will get hit with payouts and recurring monthly obligations (child support, spousal maintenance) that lower their ability to save.

Even if you have accumulated a healthy Kiwisaver account balance, you’ll have to share it with your departing partner. Most of the reading I’ve done around this topic shows that neither partner typically recovers from the cost of separation. They’re both screwed for at least a decade. On the back foot. Struggling.

There’s another massive assumption that the Kiwisaver model doesn’t take into account. That you’ll have employment consistently from 25 to 65! Just ask old guys who have 20+ years of experience in IT and have kept ahead of the curve but can’t find work in their late 40’s / early 50’s how life long employment worked out for them.

With Great Depression 2.0 likely to result in a jobless recovery and future prosperity unlikely to result in marginal workers getting hired to do “make work” stuff any time soon, the Kiwisaver account model of regular contributions has no relationship to how the modern labour market is working out.

The only group of people likely to benefit from Kiwisaver accounts are highly paid public servants. Even professionals who earn partnership income won’t benefit – they need to have access to the cash to cover their upper middle class lifestyle when finance companies go through and their firm writes off a lot of receivables!

I would go so far as to say that if the Kiwisaver model can’t work for a person earning the median (50th percentile remember) income, it is nigh on impossible for it to work for the bottom 50%. And with rising living costs and stagnating incomes, the next few deciles (60th, 70th, 80th) are unlikely to benefit from the model either.

This means that Kiwisaver accounts will cover the retirement only for people who earn really high incomes and would be saving with or without Kiwisaver anyway.They’ve opened accounts for all of their family because they can earn quick 100% return on investment from depositing $1,040 a year for the past few years.

Because of the power of compound interest, little Johnny who gets that Kiwisaver account from birth will end up with a Kiwisaver account like Mitt Romney’s 401(k) by the time he’s eligible to access it.

Kiwisaver accounts are going to be the target of increased lobbying over time. Because they’re going to become a wealth vehicle for high income / high wealth New Zealanders. They’re going to reinforce wealth inequality and make people connected to the Kiwisaver industry extremely wealthy.

Kiwisaver won’t cover your retirement because the fees will eat up most of the returns your account earns. If your fund makes 6% and you’re paying a 1.5% management, trustee and custodial fee along with a 15% performance fee that’s a net 3.6% return before inflation!

6% – (6% * 0.15) – 1.5% = 3.6%

When I read that most Kiwisaver members haven’t changed the default account they were allocated, I despair. If you can find a non-scammy Kiwisaver provider, you still can’t touch the money until you’re 65. Try asking people in genuine financial strife who tried to get money from their Kiwisaver as a last resort. Watch for more complaints around this in the future.

All of this stuff comes back to basic maths. If you want to replace your income in retirement you need to accumulate between 20 and 30 times that amount in liquid or income earning assets.

If you want to replace $50,000 in income that’s at least $1 million in income earning assets. That’s rental property, commercial property, bonds, shares, term deposits, whatever. If you don’t hit that target you have to spend your capital.

When you think about the cost of retirement that way, it’s easy to see how so many people jumped at the high returns offered by finance companies. It’s easy to see how so many people fail to do their due diligence on investment opportunities that finally offer a way out of mathematical impossibility.

But remember folks, this is an affliction mainly suffered by people who have lived above their means. A lot of “boring” people who kept their living expenses reasonable and avoided flashy stuff will be quite happy living off NZ Super and an extra $10k a year from their investments.

Simple living is the simplest way to cover your retirement. But that’s not sexy, and that’s why baby boomers will experience a whole world of pain and adjustment when their post-retirement lifestyles resemble those of the sorts of Kiwis they can’t stand and have discriminated against through the polling booths over the past couple of decades.

Instead of contributing to Kiwisaver, I’m working on small side businesses that will bring in regular but modest income streams. That’s a smarter retirement plan than transferring your hard earned cash to someone whose incentives are completely different to yours.


Dividend Yields: NZX against US Markets

I think that dividend yield is one of the most important numbers to know when it comes to shares. The whole point of investing from my perspective is to get a piece of the action. The more money that comes to shareholders as opposed to executives, the better in my opinion.

The dividend yield is calculated by dividing the share price by dividend per share. Just like the price/earnings ratio, we need to be careful about making investing decisions on the basis of one ratio however.

If there’s one big difference between the NZ sharemarket and the US sharemarket (NASDAQ, NYSE…) it is the different attitudes towards dividends. New Zealand companies have very high dividend payouts relative to US companies.

What’s the reasoning behind this? I think it has a lot to do with how dividends are taxed. In New Zealand, there is an imputation credit system where dividends can be paid with imputation credits attached.In effect, this means you only need to pay extra tax on the dividend you receive if you are in the highest income tax bracket.

The story in the United States is very different. There, the company pays tax on its profits and the shareholder has to stump up again when the dividend lands in their account. This is called “double taxation”, and as a result, some companies are reluctant to pay dividends instead preferring to invest in growth or executive compensation.

An interesting exercise is to visit the great website Top Yields. Look at the NZX50 top yields and the sorts of companies appearing. Then look at the NASDAQ and NYSE top yields and the sorts of companies appearing.

In New Zealand, pretty solid performers like our banks (which despite all of their faults have been fantastic for shareholders the past decades) and retailers. In the United States, most of the top yields come from companies best described as “second tier”.

There are several theories as to why this is. For one thing, New Zealanders have more on term deposit than they do invested in shares. Since the 1987 sharemarket crash a lot of people have avoided shares and instead focused on non-productive housing investments.

There is a cultural reluctance to admit that poorly developed local capital markets mean raising finance offshore is the only way for many domestic companies to get the capital they need. In effect, our aversion to shares is making covered bond issues in Europe and dual listings on the Australian Stock Exchange far more palatable than domestic issues.

The stalling of partial asset sales, which would provide some solid new issues for the NZX, will only make the problem worse. Substantial inflows from Kiwisaver haven’t really happened. Some analysts think that all Kiwisaver has done is change where household saving is done as opposed to the actual level of household savings.

All of this is in stark contrast to the US markets. Despite the rise of high frequency trading and quantitative easing disproportionately benefiting the holders of financial assets, they have far more domestic participation in their capital markets.

That means that even when dividends are paid in the billions, the market capitalisations they are paid out against mean really low dividend yields like 2% or even less are standard.

Many US corporations are also sitting on massive cash balances offshore or domestically, not investing it in their business or returning it to shareholders. This of course makes NZ dividend yields look substantially higher than US markets.

I believe that the only reason to own shares is to get the dividends. Capital growth is a lottery and there are no guarantees that paying a premium for average businesses will be rewarded by long term growth in earnings and dividends.

For that reason, despite the almost hegemonic influence of US corporations, their policy against paying dividends and sitting on massive cash piles makes them less attractive as options.

For Kiwi investors, the Foreign Investment Funds tax regime is another tick against participating in the US markets. You could end up with a tax bill and no cash to pay it with, forcing an early sale.

Very high dividend yields can obviously be a sign that something is wrong. A company could be in the middle of a debt crisis or PR crisis. The underlying business could be uncompetitive or struggling. But for the present time, in light of NZX performance over the last year, the dividend yields in the New Zealand sharemarket are bloody good.

A lot of the risks – political, currency, volatility, adverse external shocks – are unlikely to destroy the ability of some high dividend payers to pay their dividends. For example, if the economy continues to meander through Great Depression 2.0 the profits The Warehouse Group (Dividend Yield of 9.49%) will earn are unlikely to come to an end anytime soon.

Why Price / Earnings Ratios Matter For Investors

The price/earnings ratio is one of the most important financial ratios we can calculate for a company that’s traded on the share market. It is calculated by dividing the share price by earnings per share.

For example, Chorus Ltd, currently trades at $2.94 per share. It has earnings per share of $0.265. 2.94/0.265=11.09. This is different than the figure shown below because I used the current price rather than the opening price.

Selection_066Source: NZX

In effect, if you buy 1 share of Chorus for $2.94 (excluding brokerage), you are purchasing underlying earnings of $0.265. You won’t necessarily get all of this as a dividend, but the 11.09 ratio allows you to compare different companies share price in relation to their earnings per share.

The P/E ratio can indicate whether a share is undervalued or overvalued. That doesn’t mean its share price will have anything to do with its valuation, but can help identify speculative bubbles.

In order for a high P/E ratio to be justified, a lot of earnings growth must be anticipated. If that growth in earnings per share doesn’t eventuate, a bubble stock can quickly collapse.

Because of the incentives faced by executives of publicly traded companies, increasing earnings per share each quarter is very important. The long term profitability of their business can take a sideline to making sure they “hit the numbers” that research analysts forecast for the company.

In the Dotcom bubble of the late 1990’s and early 2000’s, some companies achieved very high share prices without any underlying earnings growth. Their P/E multiples were very high – some companies were even making losses and burning through shareholder wealth at a rate of knots.

We have to remember that calculating ratios like these and making investment decisions based on them is risky business. Because of the casino nature of the financial markets these days, the most useful thing a P/E ratio can do is help us avoid piling into a bubble stock.

It can also help us avoid buying a dog on the cheap, because we think it is “under valued”. While the efficient markets hypothesis is academic fantasy, a lot of information is contained in the price of a share. If it’s going cheap, there’s probably a solid reason behind it.

Take for example Telecom – which of course used to have Chorus before regulatory action forced structural separation in the New Zealand telecommunications market.

Selection_067Source: NZX

We take the current price of $2.275 and divide that by earnings per share of $0.536 which gives us a price/earnings ratio of 4.24. This is much lower than Chorus’ p/e ratio of 11.09.

What does this actually mean? Well, traditional finance thinking would say that Telecom is undervalued because the price/earnings ratio is so low. Robert Shiller, in his book Irrational Exuberance, posits a long term average P/E ratio of 15 for US stocks.

While it’s hard to apply US data to a New Zealand market, on a global scale, both P/E ratios are low. That’s because New Zealand is not the United States. There are many risks that lower the premium investors will pay for New Zealand earnings.

  • New Zealand has currency risk, because investments are denominated in NZD.
  • New Zealand has political risk, because the telecommunications sector has been heavily regulated over the past decade.
  • New Zealand has volatility risk, because we’re like a lifeboat in the South Pacific – movements in overseas markets can very much influence our markets.

A value investor, someone who thinks share prices will move towards their actual value as opposed to the market price, would prefer Telecom to Chorus because of the lower P/E ratio.

A trader, someone who thinks the market price is all that matters, might think Chorus is preferable to Telecom because the higher P/E ratio means more people think that way and it’s still not “overvalued” so there’s potential upside.

Price / earnings ratios matter because they can influence the decisions of a lot of people. Some superannuation funds might have rules that stop them from paying a premium for underlying earnings growth. Executives at the firm might even engage in accounting games to show steady EPS growth.

When it comes to making investment decisions, how you view the results from calculating things like the price/earnings ratio will inform your eventual decision. But we shouldn’t forget that there are lots of factors outside the model that affect ratios like this.

These include regular buying from institutional investors that must own the share to track the index their performance is benched to. It also includes the company itself engaging in Treasury buybacks where it purchases and cancels its own shares to increase earnings per share.

NZX Performance In 2012

NZX50 2012



Source: NZX

The NZX50 has had a stellar year. Financial assets around the world are outperforming because of quantitative easing and financial institutions preferring to hold assets for their own books versus taking risk and making loans.

For investors who didn’t try to time the market and held on over the past few years, they’ll have accumulated some tidy dividends and good quality shares on the cheap through buying weakness.

NZX price/earnings ratios are very low by global standards and dividend yields are very high by global standards. Because companies can increase prices in response to inflation, they’re a better inflation hedge than bonds.

The sheeple who keep piling money into housing will get their comeuppance as soon as building restrictions and land supply restrictions are relaxed. When Housing Bubble 2.0 bursts eventually, we’ll have the recession we should have had in 2008.

But Kiwis will still need to do their grocery shopping, pay for electricity and are more likely to visit The Warehouse. These are just some of the reasons why the sharemarket – by no means perfect and holy – is simply a better market to participate in than the housing market.


Due Diligence Questions For Investors

If you are thinking about investing in something, you have to do your due diligence. The finance company collapses, ponzi scheme failures and property investment scams that have been revealed following the global financial crisis ram home the fact that most investors don’t do their due diligence.

How can an average investor perform due diligence on a prospective investment? The truth is they probably can’t. If you don’t have above average knowledge of the relationship between risk and return, how probability actually works, what the law is surrounding investments and standard procedure for legitimate investment firms you should stick to investing in index funds.

The inability of the average investor to perform due diligence is why we have to make silly statements like “taking my investment advice without consulting a financial advisor or 3rd party solicitor first is really stupid”. The development of “plain English” product disclosure statements prepared in the format preferred by the Financial Markets Authority can’t account for how stupid some people are.

If you can’t explain to a reasonably clever teenager concepts like diversification, correlation of returns, the risks and rewards of Kiwisaver accounts, performance relative to benchmarks, impact of performance and management fees on long-term returns and answer questions that dullards send into Mary Holm every week you have no business going anywhere near the financial markets.

Armed with your above average knowledge of basic financial topics, you should be able to pigeon hole investment products you’re looking at. When you know the category of investment you are dealing with you can then ask the best questions for that category of investment. The Financial Markets Authority actually has some great information on its website. As does the Retirement Commission’s “Sorted”.

For example the Moa Brewery IPO can be filed under “new listing backed by guys with a track record of selling NZ brands for a premium to large corporates and non-trivial likelihood of success”. Examples of questions you’d want to answer before investing here would be:

  • How are the founders and IPO participants incentives aligned?
  • Who is managing the listing and what fees are they getting? Do they have to support the initial listing price?
  • What do the back-of-the-envelope calculations look like for the premium beer market?
  • What is the worst-case scenario if I put my money in the IPO?
  • What are the risks I am exposed to here? Currency risk? Distributor solvency risk? Consumer tastes and preferences risk?
  • Can I build a basic model in Excel that resembles what the Moa guys have put in the prospectus and test their assumptions?

If you are performing due diligence on a specific asset manager, there are lots of things you can do to lower the risk of getting “Madoffed”. Reading the disclosure documents very carefully is the first step. Then, conducting a detailed Google search on the asset manager, entities they are associated with, similar investment products, credit checks, background checks if you are investing a lot of money with one manager and testing whoever is trying to sell you the investment product with aggressive lines of questioning are all part of investigating whether an asset manager’s track record is plausible or someone is taking the mickey.

A clear understanding of probability and investment returns is also essential. Past performance does not predict future performance. Just because a hot-shot asset manager has beaten the NZX50 for the past decade doesn’t mean they possess some amazing ability. Never discount the possibility that someone has had really good luck and is rationalising their success by pointing to their “track record” and “investing acumen”.

If you’ve been reading this article and don’t understand every single concept I’m referring to, you have no business actively investing. The Financial Markets Authority should restrict investment products to people who are capable of performing due diligence independently.

Why is this? Well, it’s because in New Zealand we privatise profits and socialise the losses. If someone makes a bad investment and loses their retirement savings they will become a burden on every other Kiwi by accessing superannuation when they previously would have been able to decline it. They’ll also become eligible for nursing home subsidies if they haven’t stashed the rest of their assets in trusts.

Behavioural finance studies have proven that very few people are capable of making rational investment decisions. They are subject to enormous biases, under-estimate the likelihood that they are making a poor decision and over-estimate the likely returns from investment products they are considering. We think we know more about investing than we actually do and cry to the media when we make really dumb decisions.

I am not currently in a position to make substantial investments in hedge funds or pick individual stocks. My strategy at present is pure capital preservation and hedging against inflation. An index tracking product like the NZX SmartShares is the most reasonable level of risk I’d be comfortable with at this stage. Taking long-term bets with out-of-the-money options is too risky at present.

Handing over your entire investment strategy to a person whose incentives are not aligned with yours (think : commissions, kickbacks, golfing trips, liquid lunches at restaurants you’ve never heard of) and then losing it all is proof positive that financial darwinism exists.

If you are not prepared to do enormous groundwork in analysing potential investment products, doing the due diligence, clarifying things you don’t understand with your solicitor, asking your accountant whether claimed tax benefits are likely to result in an IRD audit or even performing a Google search on the potential investment provider and associated entities, you shouldn’t even consider index funds.

You could choose the conservative option on your Kiwisaver and keep all of your money in term deposits. But even then you’re an unsecured creditor to the Big Four banks and will get clipped if Open Bank Resolution is ever implemented. Do you even know how Open Bank Resolution will work? If not, you should take five minutes from your busy day to read about it.

I think you should read dozens of books before you go anywhere near the shark-infested waters of investing. If you don’t have a broad understanding of investing, risk and probability you are a mark for shysters who will take advantage of your naivety. Just because you have achieved success in one area of your life, namely having enough money to invest, doesn’t mean that success will transfer to your investing efforts.

I am reasonably smart. I read extremely widely in economics and finance. I have extremely low levels of confidence in the financial markets and the “professionals” who work there. Commingling of client funds and business funds, expenses being charged to investors and exceptionally poor after tax and after inflation returns make me wonder what excess return can be earned from assets even marginally more sophisticated than index funds like ETFs.

NB: For the illiterate I’m not an Authorised Financial Advisor and this shouldn’t be taken as financial advice tailored to your specific situation. If you actually don’t do your own research you are a dunce who deserves to lose everything. Search for an independent financial advisor who won’t charge commissions on investment products or read a few basic investing books before even visiting a sharebroker’s website or requesting information on something you’re unlikely to understand.