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Understanding investments and risk

Every investment carries a level of risk. There are different types of investment risk that can affect returns from your super. Understanding what they are can help you decide the level of risk that’s right for you.

What is investment risk?

Investment risk is the chance that the return of an investment is different from what’s expected. 

All investments carry risk. The level of risk depends largely on the type of investments (we call these asset classes) you’re invested in. 

Generally, investments with potentially high long-term returns, like shares, carry more risk. This is because they can go up and down in value significantly in the short term. 

Investments which are more likely to deliver lower returns are considered lower risk. They are typically more stable in the short term. But they usually don’t produce high long-term returns either. 

You can control some of your risk depending on the types of investments you choose.

How long your money will be invested for is important when it comes to investment risk. If you're still a long way off retirement, you're investing for the longer term. During that time, the market will hit rocky patches. Having a longer investment timeline means you can ride out short-term market falls.  

If you’re closer to retirement, you might choose more conservative investments. This can help to cushion your super balance from large market falls.

Risk and return

All investments carry some risk. And you need to take some risk to grow your super balance over time. 

When you combine different investments to create a portfolio you typically reduce risk. This is because not all investments go up (or down) at the same time. Sometimes, when one investment goes down, another goes up. This means returns from your portfolio overall could be more stable. 

Combining investments in this way is called diversification.

Types of investment risk

There are a number of different types of investment risk. They relate to the short, medium, and long term. 

Investment risk will impact you differently depending on your investment timeline. Your investment timeline is the amount of time you have until you retire and access your super. 

Although it may seem daunting, risk is a necessary part of investing. In fact, you can use risk to your advantage when it comes to investments. But whatever you do, it’s important to make sure the level of risk you take on is right for you.

Your appetite for risk

How comfortable you are with taking risk will likely influence the way you invest. Your attitude to risk might also change as you approach different stages of life.

Market risk

This is the risk that your super balance may drop in value because of things that affect an asset class or market. Market risk can be caused by things like economic conditions, government policy, and investor behaviour.

  • Economic conditions can include things like unemployment levels and inflation.
  • Government policy refers to the actions or decisions governments make on certain things. Examples include tax rates, immigration, and climate change.
  • Investor behaviour describes the way people invest based on current events or news. An example of this is when people move their investments out of shares after the market falls.

Inflation

Inflation risk is the chance that your super balance won’t keep up with the rising cost of living.

Longevity

This is the risk that your super balance may not last long enough to support you through your retirement. 

It's important to look at your investments from time to time. As you get closer to retirement, your investment approach may change. You want to make sure that your super savings will provide enough retirement income for as long as you need it.

Sequencing risk

This is the risk of market downturns at the wrong time. For example, at the start of your retirement, when you may not be contributing and want to access your super. 

As you get closer to retirement age, it’s a good idea to regularly review your investment options. It can also be beneficial to speak to an adviser for other ways to guard against this risk.

Security or asset risk

Individual investments, for example shares, can be affected by specific risks. An example of this is a change in a company’s operations that impacts the value of its shares. Holding a diversified portfolio across asset classes helps to manage, but not eliminate, this risk.

Standard risk measure

Each investment option performs differently. This depends on the assets that make up the investment option. Risk and reward go hand in hand. Unfortunately, investments with high returns and no risk don’t exist. The trick is to get the balance between risk and return right. Too much risk and your balance might go down in the short-term, too little and your super might not grow enough over time.

The Standard Risk Measure is a tool used across the super industry. It can help you compare the risk level between investment options.  

The Standard Risk Measure scale shows:

 

  • The risk band – this is the level of risk measured from 1 to 7
  • The risk label – this is the classification of the risk from very low to very high, and
  • The number of expected negative returns you might see over a 20-year period. 

Scroll table horizontally on mobile

Standard risk measure
Risk band Risk label Estimated number of years of negative annual returns over any 20 year period
1 Very low Less than 0.5
2 Low 0.5 to less than 1
3 Low to medium 1 to less than 2
4 Medium 2 to less than 3
5 Medium to high 3 to less than 4
6 High 4 to less than 6
7 Very high 6 or greater

 

You can see how we rate each of our investment options according to the Standard Risk Measure scale.

How to manage risk

All risk can never be completely removed. One way to manage risk is to diversify your investments. This means spreading the risk by investing in different types of assets. 

It’s a good idea to regularly review your investments to make sure they suit your life stage. You can also speak to a financial planner.

 

Related documents

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