How can young investors fight against their short-term impulses and improve their financial literacy? How can parents help set their kids up for the future? And how is the growing demand for good returns from companies that claim to do good changing the way young people invest? Helen McDowall, Head of Investments at MAS, has the answers.
NZ Geo: Humans, and especially younger humans, tend to worry about the here and now and that’s especially true given the rising cost of living. How do you get them to think about the future and start to learn about investing?
Helen McDowall: People tend to display what behavioural scientists call ‘temporal discounting’. In short, this means we tend to value things less when we have to wait for them. KiwiSaver is a classic example. When there are things you’d like to spend money on today, it can be hard to put away money for your first home or retirement when this might be years into the future.
A good way to try and combat this is to think about opportunity costs. Every dollar you spend is a dollar you could be investing and earning a return from. For example, you could spend $5 a day buying a coffee, or you could instead invest this in an aggressive fund earning an average expected net return of 5.5% per year. While the former will keep you stimulated for a few hours each day, the latter is likely to provide you with a lump sum of over $24,000 in 10 years, according to Sorted’s Savings Calculator.
Why is it so important to start investing early?
The most important reason is due to the powerful effect of compounding returns over time. Put simply, compounding returns are returns earned on returns. Let’s say you put $100 into an investment that delivers a net return of 5% each year. After the first year you would have a balance of $105, which equals your initial investment of $100 plus your 5% return of $5.
In year two, however, you start the year with a balance of $105. Over the year, you earn a return of 5% on $105, which equals $5.25, and you end the year with a balance of $110.25.
So, despite achieving a 5% return in both years, your dollar return in year two was higher. This additional 25 cents is your compounded return.
Now, multiply this effect with much larger amounts over many years and you can understand the power of compound returns. For example, if you had invested $100 in the S&P 500, a major index of large US stocks, at the start of 1950, your balance would have grown to over $200,000 by the end of 2022. And that’s without ever having made any additional contributions over that time.
Parents play an important role in their kids’ financial future, whether it’s helping to increase their financial literacy or chipping in some funds. What advice do you give to parents?
Setting up a KiwiSaver account for your child can be a good way for you to help them save for their first home or retirement.
The main reason for this is because your child will pay tax at their personal PIR tax rate, which is likely to be 10.5% per year if they have no other income.
This is much more tax efficient than saving on their behalf under your own name, as if you’re employed and earning over $48,000 a year you’ll likely have a PIR tax rate of 28%, almost three times higher.
The difference tax can make over time can be pretty large. Let’s say your fund earned a net return after fees of 7.5%. Your after-tax return would be 6.7% with a tax rate of 10.5% but only 5.4% if you were taxed at 28%. That’s a 1.3% difference in net return each year. Compound this over time for say 18 years and this can mean thousands of dollars of forgone earnings.
However, there are a couple of things to note when thinking about setting up a KiwiSaver account for your child. Firstly, they won’t receive Government contributions until they turn 18, and if they’re working, they generally won’t receive employer contributions until they’re 18 either.
Secondly, generally your child cannot withdraw the money in their KiwiSaver account until they buy their first home or retire. However, this could also be seen as a benefit, if you are contributing money to their account for their first home or retirement and you want to ensure they can’t spend it on other things when they leave home.
Is the desire to have your money invested ethically increasing in the younger generation? How is that affecting investing in general? And does MAS and its work through the foundation appeal to that mindset?
Environmental, social and governance (ESG) investing has had a significant impact on the market. By some estimates, around a third of funds under management globally are invested with ESG factors in mind.
Surveys show that younger people are particularly interested in ensuring their investments align to their values. That said, we are also seeing a big uptick in greenwashing concerns across all age groups. Part of the reason for this is because ESG analysis is subjective and the three goals of improving environmental, social, and governance [performance] can sometimes come into conflict. For example, a company might improve its ESG score by developing an ethics policy (governance) even though its carbon emissions (environment) continue to rise.
While we believe ESG integration has an important role to play, it cannot be the end goal in itself. As a result, our approach to responsible investment focuses on more objective outcomes. These include targeting companies providing climate solutions, restricting our exposure to certain industries that are harmful to the climate or human health, and by using our shareholder influence to drive change within the companies we invest in.
The MAS Foundation complements this approach and in FY22, distributed $2.6 million to improve health and wellbeing equity throughout New Zealand. The money was used to support a range of community-led initiatives including assisting vulnerable women in unexpected or crisis pregnancies, helping people at risk of recurrent cardiac attacks to become smoke free, and funding groups addressing gang violence and drug addiction in their communities.
Where would young people get more information about investing?
MAS hosts regular financial literacy events and presentations to members, with a real focus on tertiary students. We have a team of student advisers based in and around universities who meet with students and help them understand how to protect their assets and achieve their first home goals. Many of the students we work with have relatively low levels of financial literacy and really appreciate learning how they can get ahead financially when they graduate.
Medical Funds Management Limited is the issuer and manager of the MAS KiwiSaver Scheme. More information and the PDS for the Scheme is available at mas.co.nz/kiwisaver