Asset allocation is an important part of your KiwiSaver strategy. However, despite its importance, it is not understood well enough by investors. Additionally, if you don’t pay enough attention to asset allocation, it could cost you hundreds of thousands of dollars over the course of your lifetime.
You might be wondering: how does asset allocation work? What goals does asset allocation aim to achieve? And why should you as a KiwiSaver investor care about this concept? This blog post will aim to answer questions like this.
What is asset allocation, and what do I need to know about it?
Asset allocation is how your money is distributed between different investments. It is the idea that assets should be distributed depending on your personal circumstances. These factors include things such as your age, years until you withdraw your money, and risk tolerance.
Asset allocation has a number of purposes. We will talk about three of them in this post:
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Asset allocation increases or decreases the average expected return of your portfolio
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Asset allocation increases or decreases the volatility of your portfolio
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Asset allocation gives you exposure to different types of investments
1. Asset allocation can change the average expected return of your KiwiSaver portfolio
The way your KiwiSaver provider chooses to distribute your money is important. This is because the way they do can change your expected return. After all, no two KiwiSaver providers are the same.
Cash KiwiSaver funds, and any fund with a large amount of cash assets, generally do not earn you a lot of money per year. This is because their funds are invested in assets with lower returns. For example, cash funds may invest in Government bonds (which loan money to the Government) or corporate bonds (which loan money to companies). Sometimes your money will remain in cash or cash-like assets.
However, growth and aggressive funds generally are the highest earning funds in the long run. This is because most of their funds are invested in assets with higher returns. This includes investments into New Zealand companies, overseas companies, or maybe even start-ups. High returning assets like these are known as growth assets.
The average expected returns of different types of funds can be illustrated by the continuum below.
KiwiSaver providers allow you to change your fund type if you request so. Usually, you can do this online. But should we all choose to change our KiwiSaver fund to a high return one? As a matter of fact, the answer is no, and this is because of the next point below.
2. Asset allocation can change the volatility of your portfolio
This is an important point that should not be overlooked. Different people have different tolerances for volatility due to a variety of reasons. Therefore, no fund is right for everyone.
An advantage of any fund with a large amount of cash assets is that they create more consistent returns for investors. This is because the returns of cash and cash-like assets such as bonds do not fluctuate widely due to their lower volatility. Although the return of these assets may be low, the level of returns will be somewhat consistent.
The chances of losing your entire investment through these investments are also smaller. For example, it is unlikely in many countries that the Government will be unable to pay back the money lent to them through government bonds. This is because they can do things like increasing taxes to pay off their debt.
The volatility of different funds can also be illustrated using the continuum below.
As you might be able to see from our two continuums, the highest returning funds are also the funds with the highest volatility. In other words, the higher the volatility of a fund, the higher the expected return in the long-run and the lower the volatility of a fund, the lower the expected return in the long run.
You can learn more about the different types of KiwiSaver funds here.
3. Asset allocation can give exposure to different types of investments
Through asset allocation, providers expose your money to a variety of different investments. This may include tech companies, overseas investments and even start-ups.
Generally, providers aim to invest in a variety of places for diversification. Simplicity, for example, invests in 23 countries and more than 3,000 investments. This is done to lower the risk that when one type of asset significantly decreases, there isn’t a sharp drop in the value of your whole portfolio.
For example, think back to when the sharemarket decreased in March 2020 due to Covid-19 fears. While share prices generally went down, other assets such as Government bonds would have still earned money. This would have offset some of the losses incurred during those months. Additionally, companies such as Zoom have boomed during the Covid-19 pandemic, further offsetting losses made by other companies.
What type of asset allocation is best for me?
The best type of asset allocation depends on your specific circumstances. There are lots of different factors involved that will change which fund asset allocation is best for you.
The great thing though is that National Capital offers a free financial advice service to help you figure out which provider is best suited for you. Watch the video below to understand why our clients trust National Capital.
We also take into account all the other factors not covered in this article when deciding which KiwiSaver provider and fund type is best for you. Additionally, you’ll get the privilege to talk to a real person for free about your personal KiwiSaver situation. This will allow you to clarify any other questions that you may have.
In order to take advantage of this service, simply head to our KiwiSaver HealthCheck and fill it out. It’s free for you and will only take a few minutes to do.
So what are you waiting for? Fill out our KiwiSaver HealthCheck now and get the personalised advice you need for your situation.