In our previous posts, we showed you how we calculate what lumpsum you need at retirement, what rate of return you need from your KiwiSaver Fund and the amount you need to contribute to get you there.
This gives us what we call the ‘KiwiSaver Returns Required’. But does that give us the answer on which KiwiSaver fund we should be in? No.
KiwiSaver Returns Required is only the first factor which goes into your decision. There are a few more factors you need to take into consideration. Here are two more.
Factor 2 : Volatility Capacity
Your savings in KiwiSaver will be invested, some or maybe a lot of it in the stock market. This means as the stock market goes up and down so does your KiwiSaver balance.
The general consensus is to ignore the short term volatility, as the long term trend of the stock market is increasing. However, if the market drags your KiwiSaver balance down just at the time your plan on withdrawing your funds for retirement expenses, then this volatility can really hurt you as it will crystallise those paper losses.
This is where Volatility Capacity comes in, which is simply your capacity to withstand the ups and downs of the stock market and your KiwiSaver balance.
So how do you calculate Volatility Capacity?
Some people use a general rule of thumb - the older you get, the lower your capacity is. However, it’s a bit more nuanced than that.
Your age is only one factor in your capacity to withstand volatility. You need to take your retirement age into consideration and more importantly at what age you will need to start drawing down on your KiwiSaver funds to pay for your living expenses. Then you need to account for the longevity of your retirement. There will potentially be a portion of your KiwiSaver money you will need right away, but you may only begin drawing down on the rest, say 10 years into retirement. Your Volatility Capacity for that ‘bucket’ of money will be different at each stage of your life.
Factor 3 : Volatility Tolerance
We’re human beings, all of us (except maybe the aliens hiding among us). And we've all got human biases and feelings. These include fear - it’s hard to stay calm when we see our KiwiSaver balances falling.
Again, the general consensus is to ignore this short term volatility. But each one of us is unique when it comes to our ability to just ignore it. So measuring and knowing your Volatility Tolerance is very important in investing. You do not want to overstretch and be invested in a very aggressive investment, only to throw in the towel when the markets are down. That’s a sure fire way to lose money.
The 3 factors - now what?
So we’ve got our three factors - KiwiSaver Returns Required, Volatility Capacity and Volatility Tolerance. What now? Should we invest in a KiwiSaver fund which can get us the returns we require or should it match either to our Volatility Capacity or Tolerance?
We've seen that in most cases these three factors can all point to different direction for a single client. It’s here where a financial adviser such as National Capital can help you figure out how each of those factors play into your final decision. Depending on other factors in your personal financial situation - each of these 3 factors need to be given a different weighting. Ultimately it's a combination of these 3 which will give us the final answer!