How to Choose the Right KiwiSaver Fund for Your Age

Understanding How KiwiSaver Fund Choices Work

One of the most significant factors affecting your KiwiSaver balance at retirement is which type of fund your money is invested in. The difference between fund types can result in variations of $100,000 or more over a working lifetime, depending on market conditions, time horizons, and contribution levels.

However, there's no single "correct" fund choice that applies to everyone. Fund selection involves trade-offs between potential growth and potential volatility, and these trade-offs have different implications depending on individual circumstances.

This article explains how different KiwiSaver fund types work, the mathematical relationship between investment timeframes and risk, and the factors you might want to consider when reviewing your fund allocation.

The Five Main Types of KiwiSaver Funds

Most KiwiSaver providers structure their offerings around four to five main fund categories, although naming conventions vary between providers. Understanding what these categories actually mean helps when comparing options.

Defensive/Conservative Funds (typically 0-25% in shares): These funds invest primarily in cash deposits and bonds (debt securities issued by governments and companies). Bonds provide regular interest payments and return the principal at maturity. Because shares make up a small portion or none of the portfolio, these funds experience relatively low volatility. Historical returns have typically ranged from 3-5% annually over long periods, though this varies with interest rate environments.

Conservative Funds (typically 25-50% in shares): These funds split investments roughly between growth assets (shares) and income assets (bonds and cash). This creates a portfolio that participates in sharemarket growth while maintaining a significant allocation to more stable assets. Volatility is moderate compared to other fund types.

Balanced Funds (typically 50-65% in shares): These funds have a majority allocation to shares but retain a substantial bond and cash component. This is the most common default fund type in New Zealand. These funds experience genuine market volatility but the fixed-income allocation provides some cushioning during sharemarket declines.

Growth Funds (typically 65-85% in shares): With a strong majority in shares, these funds are heavily exposed to sharemarket movements. In years when sharemarkets perform well, returns can be substantial (potentially 12-15% or more). In years when markets decline, losses can also be significant (20% declines or more are possible). The bond allocation provides limited diversification.

Aggressive/High Growth Funds (typically 85-100% in shares): These funds are almost entirely invested in company shares across New Zealand and international markets. They experience the full force of market volatility, both up and down. These funds have historically provided the highest long-term returns but also the largest year-to-year fluctuations.

The fundamental principle: Higher allocations to shares have historically produced higher long-term returns but with greater short-term volatility. The question facing investors is how much volatility they can accommodate given their circumstances.

How Time Horizon Relates to Investment Risk

One of the foundational concepts in investment theory is the relationship between time horizon and risk capacity. This relationship is mathematical, not just philosophical.

The compound returns equation: According to long-term historical market data (drawing on international sharemarket returns over rolling 30-year periods), equity portfolios have returned approximately 7-8% annually after inflation, while conservative fixed-income investments have returned closer to 2-3% after inflation. Over short periods, this difference may seem modest. Over long periods, the compound effect is substantial.

For example, $50,000 invested at 7.5% annual return for 30 years grows to approximately $379,000. The same amount at 2.5% grows to approximately $105,000. The difference is $274,000, purely from the compounding effect of the return differential.

Volatility and recovery periods: Sharemarkets experience periodic declines. Since 1980, New Zealand and international sharemarkets have experienced roughly seven significant corrections or bear markets. Some examples:

• The 1987 crash saw markets decline approximately 30-40%
• The 2000-2002 tech crash resulted in declines of 40-50% in some markets
• The 2008-2009 Global Financial Crisis caused declines of 40-50%
• The March 2020 COVID-19 crash saw rapid declines of 30-35%

Importantly, in each case, markets eventually recovered and went on to reach new highs. However, recovery periods varied from 18 months to over five years. This is why time horizon matters: longer timeframes have historically provided more opportunity to experience and recover from these cycles.

Sequence of returns risk: The order in which returns occur matters significantly. An investor who experiences a 30% decline in their final year before retirement has fundamentally different outcomes than an investor who experiences the same decline 20 years before retirement. This is called sequence risk, and it's why the same fund type can produce very different real-world outcomes depending on when it's held.

The Transition Concept: Why Static Allocations Often Don't Make Sense

Investment theory suggests that optimal asset allocation isn't static over a lifetime. This concept is called a "glide path" - a gradual adjustment in the risk profile of investments as time horizons shorten.

The rationale: When retirement is 30-40 years away, there is substantial time to recover from market declines. Historical data shows that virtually all rolling 30-year periods in developed sharemarkets have produced positive returns. As retirement approaches and the timeframe shortens to 10, 5, or 2 years, the probability of experiencing a significant decline without sufficient recovery time increases.

Many KiwiSaver providers offer "life stages" or "target date" funds that automatically implement a glide path, gradually reducing share allocations over time. These funds typically charge slightly higher fees for this automated service.

The trade-off in protection: Reducing risk as retirement approaches provides downside protection but also reduces growth potential. For someone whose KiwiSaver balance is already sufficient to meet their retirement goals, protecting capital may be more valuable than additional growth. For someone whose balance is insufficient, maintaining higher growth potential for longer may be necessary despite the volatility, though this comes with the risk of further losses.

There is no mathematical formula that determines the "correct" glide path for every individual because it depends on factors including current balance, contribution levels, retirement spending needs, other assets, risk tolerance, and life expectancy.

How Fees Impact Long-Term Returns

KiwiSaver funds charge annual management fees, typically expressed as a percentage of your balance. These fees are deducted automatically and may not be immediately visible, but their long-term impact is substantial due to compounding.

The mathematics of fee impact: Consider a KiwiSaver balance of $200,000 with 30 years until retirement, assuming a 7% gross annual return before fees:

• At 0.30% annual fees, the final balance would be approximately $1,337,000
• At 0.80% annual fees, the final balance would be approximately $1,160,000
• At 1.30% annual fees, the final balance would be approximately $1,010,000

The difference between 0.30% and 1.30% fees is approximately $327,000 over 30 years on this example. This is not a small consideration.

Passive vs. active management: Passive (or index) funds simply track a market index and typically charge lower fees (often 0.25-0.50%). Active funds employ professional managers who attempt to outperform the market through security selection, and typically charge higher fees (often 0.80-1.50% or more).

Whether active management justifies higher fees is an ongoing debate in investment theory. For active management to benefit the investor, the fund must outperform its benchmark by more than the fee differential after taxes. Research on this question shows mixed results, with some active managers consistently outperforming and many failing to do so.

Where to find fee information: Every KiwiSaver fund must publish a Product Disclosure Statement (PDS) that includes fee information. Fees are also shown on annual statements. The Sorted KiwiSaver Fund Finder allows comparison of fees across providers.

Understanding PIE Tax Rates in KiwiSaver

KiwiSaver funds are structured as Portfolio Investment Entities (PIEs), which have specific tax treatment that differs from other investment structures.

How PIE tax works: Instead of investment returns being taxed at your personal income tax rate, they're taxed at your Prescribed Investor Rate (PIR). Your PIR is determined by your income over the previous two tax years:

• 10.5% PIR: If your annual income was $14,000 or less
• 17.5% PIR: If your annual income was between $14,001 and $48,000
• 28% PIR: If your annual income was $48,001 or more

Importantly, the PIR is capped at 28%, even though the top personal tax rate in New Zealand is 39%. This means that higher-income earners receive investment returns in KiwiSaver taxed at a lower rate than they would pay on equivalent investments outside the PIE structure.

Why this matters: If your PIR is set incorrectly with your provider, you may pay too much tax (if it's set too high) or receive a tax bill from Inland Revenue (if it's set too low). You can check and update your PIR through your KiwiSaver provider's online portal or by contacting them directly.

More information about PIR rates is available on the Inland Revenue website.

Common Behavioural Patterns That Undermine Returns

Investment research consistently identifies several behavioural patterns that tend to reduce long-term returns:

Market timing attempts: Switching from growth funds to conservative funds after markets have already fallen locks in losses. Conversely, moving to growth funds after strong performance often means buying when markets are expensive. Research shows that most attempts at market timing reduce returns compared to maintaining a consistent allocation.

Recency bias: The tendency to assume recent performance will continue leads investors to chase last year's top-performing fund. However, fund performance is cyclical, and past performance is explicitly not indicative of future results. Market cycles mean that different fund types outperform in different periods.

Excessive conservatism when young: Being in a low-growth fund when retirement is decades away means forgoing the compounding benefits of higher-return assets during the exact period when time horizon allows for it. This is mathematically costly over long periods.

Excessive risk when nearing retirement: Maintaining high sharemarket exposure with a short time horizon creates sequence risk. A significant market decline shortly before or in early retirement can permanently reduce lifestyle options because there's insufficient time to recover or the need to sell assets at depressed prices for living expenses.

Paralysis and inaction: Many KiwiSaver members have never actively reviewed their fund choice and remain in default allocations that may not align with their current life stage or circumstances.

How to Switch KiwiSaver Funds

If you determine after reviewing your circumstances that a different fund type or provider may be more suitable, the mechanics of switching are straightforward.

Switching funds within your current provider: This can typically be done online through your provider's member portal. Most providers allow unlimited fund switches with no fees or penalties. The switch usually takes effect within 5-10 business days, depending on the provider's processes.

Switching to a different provider: This involves completing an application with the new provider, who will then arrange the transfer of your balance. The process typically takes 4-6 weeks to complete. There are no penalties, exit fees, or tax consequences for switching providers (though your current provider may charge a small administrative fee). Your contribution history and government contributions transfer with your balance.

During a provider switch, you remain invested in your existing fund until the transfer completes, so you don't miss out on returns during the transition period.

Questions to Consider When Reviewing Your Fund Choice

Rather than following prescriptive rules, these are questions that may be relevant when evaluating whether your current KiwiSaver fund allocation still makes sense for your situation:

Time horizon questions:

• How many years until you plan to access your KiwiSaver? (You can withdraw from age 65, or earlier in some circumstances)
• If you experienced a 25% decline in your balance, would you have time to wait for a potential recovery?
• Do you expect to draw down your KiwiSaver gradually over 20-30 years or more quickly?

Financial position questions:

• Is your current KiwiSaver balance on track to meet your retirement income goals when combined with NZ Superannuation?
• Do you have other investments or assets that provide security, allowing you to take more risk in KiwiSaver (or vice versa)?
• Are you maximising your contributions to receive the full employer match and government contribution?

Risk capacity and tolerance questions:

• How would you respond emotionally to seeing your balance drop 20-30% in a year? Would you be tempted to switch to a more conservative fund?
• Do you understand the volatility characteristics of your current fund type?
• Is protecting your current balance more important than maximising growth?

Cost-benefit questions:

• What annual fee percentage are you paying, and how does it compare to similar funds?
• If you're in an actively managed fund paying higher fees, has it consistently outperformed lower-cost alternatives by more than the fee difference?
• Is your PIR set correctly based on your income level?

These questions don't have universal "correct" answers. They're starting points for evaluation and discussion with a qualified adviser.

Resources for Further Research

Several organisations provide educational resources and tools for understanding KiwiSaver:

• Sorted.org.nz: The government-funded financial education site includes a KiwiSaver fund finder tool, retirement calculator, and educational content about fund types and fees
• Financial Markets Authority (FMA): The regulator's KiwiSaver section includes information about how KiwiSaver works, your rights, and how to compare providers
• Morningstar: Provides independent research and ratings on KiwiSaver funds, including performance comparisons and fee analysis
• Consumer NZ: Publishes regular KiwiSaver performance comparisons and educational articles

Every KiwiSaver provider must also publish a Product Disclosure Statement (PDS) for each fund, which explains the fund's investment approach, risks, fees, and historical performance. These are available on provider websites.

This article is general information only and does not constitute personalised financial advice. Everyone's situation is different. For advice tailored to your circumstances, speak with a licensed Financial Advice Provider. You can find a registered adviser at fma.govt.nz.

Summary: The Core Principles

Understanding KiwiSaver fund allocation comes down to several evidence-based principles:

Time horizon and risk capacity are mathematically linked. Longer timeframes have historically provided more opportunity to recover from market volatility, which is why investment theory suggests that risk capacity generally decreases as retirement approaches.

Fees compound over time. A seemingly small fee difference of 0.5-1.0% annually can result in differences of tens of thousands of dollars over a full career due to the compounding effect.

There is no universal "correct" allocation. The optimal fund choice depends on individual circumstances including time horizon, current balance, retirement goals, other assets, risk tolerance, and personal circumstances.

Behavioural discipline often matters more than fund selection. Avoiding panic switching, maintaining consistent contributions, and not chasing recent performance tend to produce better outcomes than attempting to perfectly time fund changes.

Regular review is valuable, but frequent switching is not. Reviewing your allocation every few years or at life stage transitions makes sense. Switching based on quarterly or annual performance typically doesn't.

Most importantly, KiwiSaver fund selection is not a decision that must be made in isolation. Licensed financial advisers can provide personalised guidance that accounts for your complete financial situation, not just general principles.