As your KiwiSaver fund gets bigger over time, and as you age and get closer to retirement, you’ll likely care more and more about the performance of your KiwiSaver fund.
If you apply these concepts I’ve learnt the easy way, and the hard way, they’ll serve you well in the good times and particularly well the bad times, helping you reach your financial goals.
1 | Understanding Phases Of The Business Cycle
Reading this first section serves an important purpose - It provides the base for understanding how to make more and risk less with your hard earned savings.
Gross Domestic Product (GDP) serves as a key indicator of economic health. Any fluctuations in GDP can signal shifts in the business cycle. Although the length of each business cycle can vary, it is generally categorised into four distinct phases:
Growth/Expansion
This is when the economy is booming, with rising employment and consumer spending. Businesses expand, and everything seems to be on the upswing.
Peak
Here, the economy hits its highest point. Growth stabilises, but inflation can creep up, leading to higher costs.
Recession
This is when economic activity declines. We see falling GDP and rising unemployment, and businesses often cut back on investments.
Trough
This phase represents the low point of the cycle before the economy starts to recover.
These cycles are influenced by various factors like consumer confidence, interest rates, and global events.
““Understanding the business cycle , keeping a cool head through each phase of the cycle, and staying a course that is true to your wealth and retirement plan is crucial for retaining your hard earned savings.””
2 | Understanding The Phases Of The Market Cycle
Accumulation
This phase follows a prolonged bear market and is characterised by renewed investor optimism. During accumulation, stock prices are low, but perceived value is high. This phase aligns with the expansion period of the business cycle.
Mark-up or Uptrend
In the mark-up phase, investor enthusiasm surges as the market trends upward with increasing trading volumes. Valuations begin to rise, approaching historical averages. This phase is often referred to as a bull run, culminating in the market's peak, known as the bull market peak.
Distribution
At this stage, the market reaches the peak of the bull run. As the initial excitement wanes, many investors find themselves stuck in this phase, where prices struggle to rise and trading volumes decrease. This period can last a while, and even minor negative news can trigger significant sell-offs.
Mark-down or Downtrend
This phase represents the opposite of the mark-up phase, where investor optimism turns into disappointment and extreme pessimism takes hold. A sell-off occurs, causing prices to plummet as confidence erodes and sentiment turns negative. The market enters a bear phase, eventually reaching a bear market trough, at which point prices stabilise and a new market cycle begins. Ultimately, market prices reflect human behaviour and decision-making.
The market would be easy to predict and navigate if it followed the business cycle. Instead it leads the business cycle as investors price into the market what they expect to happen in the future with the business cycle.
“Understanding the business cycle and keeping a cool head through each part of the cycle is crucial for making the best gains without the least risk. These cycles trigger a mixed bag of emotions, but they’re all related to only two - Fear and Greed, and we need to keep these in check.”
3 | The Psychology of Investing - Understanding Your Emotions
If you really want to nerd out, read Mastering the Market Cycle: Getting The Odds On Your Side, by esteemed economist Howard Marks.
However, if you can't be fussed reading it and just want a summary, he highlights that many of the extreme reactions—both positive and negative—within business and market cycles stem from investor psychology.
For investors, and anyone with a Kiwisaver fund where the balance size is starting to matter for them, recognising these fluctuations over time is essential for mitigating the risks associated with these unpredictable shifts.
During mark-down and recession phases, the media often amplifies this fear, and in turn the fearful psychology of the population compounds and growth assets such as shares and property spiral downward.
“To the investor, it feel like there’s no end in sight. Adding to that, a serious downturn can last for years. Understanding how your emotions can fluctuate through different market phases, and recognising these emotions within yourself, is one of the most important concepts to remember throughout your investment journey.”
4 | Understanding Drawdowns
This chart shows TEN years of price fluctuations for a Growth Kiwisaver Fund with one of the better performing providers in New Zealand.
The performance history above looks similar to the market cycle graph we studied before with ups and downs over time.
This chart shows the good times with the GREEN arrows (mark-up phase), and the hard times with the RED arrows (mark-down phase).
I've then highlighted the percentage gains in GREEN, and the percentage losses in RED.
We express the percentage losses with the term 'Drawdown'.
5 | Understanding Black Swan Events
In the investment world, we refer to events like the GFC (Global Financial Crisis) back in 2008 or COVID-19 in 2020 as ‘Black Swan’ events.
When COVID-19 hit, many who had their savings in Growth or Aggressive allocations watched their hard earned money plummet by over 30% in only two months.
Some funds with heavy exposure to indices saw drawdowns of 35% plus.
The transition from peak to to trough was extremely quick with the emotional shock and unknown consequences of what was the first global pandemic in one hundred years.
The unknowns of the situation caused a lot of fight or flight reactions - Those without help and knowledge had it tough - Emotions were on high alert, which led to panic, which led to poor financial decisions.
A lot of people changed into more conservative allocations right at the bottom of the trough. This solidified their losses as the market shifted into expansion not long after. It was an easy mistake to make if you didn’t have guidance.
The more astute Kiwisaver fund managers experienced Growth Fund drawdowns of less than 25% during the ‘Black Swan’ market event of COVID-19.
The best performing Kiwisaver provider achieved a mitigated 18% drawdown for their growth fund which was a better result than many balanced funds across New Zealand.
It then bounced back faster with stronger gains than those that took bigger hits. This portrays the result of excellent active management.
What I noticed as an adviser, is that it was those people with larger Kiwisaver balances that were most at risk of making incorrect, emotionally charged decisions.
The larger the Kiwisaver balance, the bigger the drawdown in dollars, and the harder it was for an investor to keep to the course and hold strong.
This is a good example of why an investments allocations need reviewing periodically.
If a fund experiences a large drawdown during a mark-down phase, and does not have an exceptional performance through the following accumulation phase of the market, it will take the balance longer to crawl back to its previous high. This usually returns less for the investor through the following mark-up phase into its next peak.
“Pulling off successful mitigation of the drawdown is one of the biggest advantages an active manager can hold over its competitors.”
Let’s go back a little bit further in time.
Look at how the S&P500 was affected with the DotCom bubble then the GFC (Global Financial Crisis).
How would you be feeling if you woke up tomorrow and your Kiwisaver balance had fallen by over 50%?
6 | So, How Do We Prepare?
If you’re in your 30’s or 40’s, or even 50's, you may experience several black swan events before you retire.
We need to a) establish your risk profile i.e. what drawdown percentage you'd be OK with, then b) consider how long your investment horizon is, i.e. what is the amount of time before you will be using the savings, and c) balance these factors against your overall financial goals in Planolitix.
Once we have A, B and C understood, we can determine a drawdown potential you’re personally comfortable with, then balance it against the drawdown potential your long-term plan and objectives suit.
As an adviser, I look back through the history of Kiwisaver funds, and establish the drawdown percentage appropriate for you.
I can then structure your Kiwisaver allocations to your needs so you are ready to go before the next black swan flies in.
Adding to that tailored approach, the Kiwisaver providers I work with allow us to structure your Kiwisaver across multiple risk allocations and markets, not just one.
“This mitigates the drawdown potential further, allowing your savings to climb back faster after the accumulation or trough phase, then allowing the next growth phase in the market cycle to grow your money faster.”
7 | How To Choose A KiwiSaver Fund?
This video explains the #1 thing to check when you choose your Kiwisaver fund.
8 | Understanding Retirement Planning
Keep in mind that ALL of these Kiwisaver and investment concepts are just one part of the puzzle and applying them won’t be all you need.
First of all, and most importantly, you need a plan. We call it your 'Wealth and Retirement Plan'.
Without a plan to work backwards from, you’re just guessing as to how to correctly structure your Kiwisaver.
We use technology to understand what elements need to come together for you to achieve financial independence by retirement, and confirm at what age that might be.
This tool helps us understand what your financial goals and ambitions are visually, so we can structure your Kiwisaver risk appropriately i.e. we need to answer questions like ‘should you pay off your mortgage first or invest?’
Without the right tools to help you establish a plan, it’s simply guesswork. You're simply flying blind.
This video below briefs you on the planning tool we use with our clients.
Hope this helps!
Chris George | Personal Finance Adviser
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Note: Any information provided is for general and educational informational purposes only and is not personalised advice. Your circumstances are unique and there’s no templated road to a cushy retirement! For personalised advice, please book a Strategy Call.