This week is Sorted Money Week - the annual public awareness and engagement campaign coordinated by Te Ara Ahunga Ora to help demystify money. The 2022 theme is “just wondering” - to encourage people to talk about money and be unafraid to ask questions. We decided to tackle the topic of inflation, so if you’re wondering how it works and what you can do to protect your KiwiSaver fund, read on.
We have all heard the news: inflation is the highest it has been in over 30 years. We feel the pain at the pump, when grocery shopping, and pretty much everywhere we spend our money. Our KiwiSaver funds have been affected, with many of us seeing drops in our fund balance.
How does inflation affect KiwiSaver? Better yet - how can KiwiSaver help us combat inflation?
What is inflation?
Inflation is when the value of a dollar goes down, so the same amount of money gets you less than it used to. This is measured by the consumer price index (CPI) which is the average price of goods and services purchased by a typical NZ household. The current CPI shows that we are paying, on average, 7.3% more for goods and services now than we were a year ago.
Inflation covertly erodes our savings; you may not see your bank balance decrease but what you have in savings is not worth as much as it used to be. The same goes for our investments, including KiwiSaver.
The Reserve Bank of New Zealand’s inflation calculator allows us to step back in time and compare prices in today’s money. A basket of goods that cost $100 in 2000 would now cost $168. We can’t estimate what that will look like in another 20 or 40 years because we don’t know what’s going to happen.
You want to be sure that when you retire, you have enough savings for a comfortable lifestyle despite inflation. The good news is that you can invest your KiwiSaver in a way that gives you the best chance of earning a return after fees, tax and inflation.
How inflation affects your KiwiSaver investment
By understanding how inflation and rising interest rates affect market assets, we can see how our investments will be affected.
KiwiSaver funds are diversified portfolios invested in a mix of assets to spread your risk. Your fund type and provider determine how much you have invested in each asset class. Assets are primarily shares and bonds. Lower risk funds also invest in cash and property but, because they are low risk, they are impacted by market changes to a lesser degree than shares and bonds.
Let’s look at how bonds and shares differ in response to rising inflation and interest rates.
What it is: A bond is a loan to a large company or the government in exchange for interest payments.
How it works: When you invest in a bond, you receive regular interest payments. If you hold your bond until maturity, you will be repaid the face value of the bond.
How they respond: High inflation lowers the value of the interest you earn. When interest rates rise, bond prices fall.
Why: When new investors purchase a bond at a higher interest rate, the value of the existing bonds gets marked down until the return matches the new (more expensive) bond. This is why conservative KiwiSaver funds have had relatively poor returns this year.
But all is not lost - there is a positive side. As existing bonds mature, investors can reinvest their money in new bonds paying a higher rate.
So what the bond investor needs is patience. Let existing bonds mature, reinvest in new bonds at the higher rate, and see a return from bonds creep back up over time.
What it is: Shares are a measurement of stock. They represent a stake in a business. Shares are more volatile than bonds, with sharper and more rapid price changes.
How it works: If the business does well, you earn money through dividends paid to shareholders or by selling your shares for a higher price than you paid. If the company you invested in doesn’t do well, the share price falls, and you stand to lose money.
How they respond: Share prices initially fall in response to shocks.
Why: Share prices fall as businesses' earnings are reduced. It takes time for businesses to adjust to a shock (whether from a viral outbreak, terrorist attack, severe drought, etc). Right now we are feeling the shock of a sudden spike in oil prices, inflation, and interest rates. As prices for goods and services rise to reflect rising inflation, profits and share prices will recover.
So the shares investor also needs patience. Wait for businesses to adjust - change supply lines, train new staff, adjust their output to match demand, raise prices or increase sales. The share prices will adapt to the new environment and resume their upward climb.
KiwiSaver fund type and asset mix
The KiwiSaver fund type you are invested in determines the weight of your investment in each asset class.
Conservative funds will have more invested in bonds than shares. Growth funds, being higher risk, will have more invested in shares. Balanced funds sit somewhere in the middle with a balance of bonds and shares. Each KiwiSaver provider sets the proportion of their fund invested in each asset class.
No matter what fund type you are in, have patience. As Warren Buffet has said, the stock market is a device for transferring money from the impatient to the patient. Stick to your strategy, focus on your goals and let the market do its work.
But first, you need to make sure you have a good strategy. This is where BetterSaver comes in - we are your go-to KiwiSaver experts.
Set the right KiwiSaver strategy to counter inflation
If you are a client of BetterSaver, we have done the work for you to ensure your investments can combat higher inflation. We have analysed over 240 funds and identified those that have delivered the results after fees that will help tackle rising living costs. By taking our fund finder quiz, you have been matched to a fund that works for your goals.
Whether a conservative, balanced or growth fund is best for you will depend on your time frame and particular circumstances and goals, but each one will help you weather the cost of living crisis over the medium to long term.
You can be confident that we are monitoring the market and KiwiSaver funds to continue providing you with the best options. It is up to you to contribute enough to your fund and to check in with us any time you have a change in circumstances to stay on track.
It is alarming that many people withdraw money from their KiwiSaver funds to manage the higher cost of living. Last September’s Financial Market Authority’s KiwiSaver Annual Report showed that financial hardship withdrawals were up 42.8% from 2020. While day-to-day survival takes precedence, it comes at a cost to our futures - we must weigh our options carefully.
The best thing to do now is to evaluate your own situation. Use our KiwiSaver calculator to see how much you could have in your KiwiSaver account and if it will be enough to meet your goals. Try our cost of living calculator to see how long your KiwiSaver fund can last you in retirement.
Next, make sure you are getting the most out of what KiwiSaver has to offer so you can retire worry-free. The fund you are in and how much you contribute can mean the difference between a comfortable retirement or working for the rest of your life.