Risk is the foundation of investing. Do you know what kind of risk your investments have?
What is risk?
The difference between investment options are generally defined by two things: the potential returns and the risk of seeing a negative return (or loss).
Short-term risk is the risk that the value of your investments – the basis of your super savings – will be reduced by volatility in investment markets.
If you’re in a position where you want to retire soon, preserving your retirement savings may be your focus. In that case, you’re likely to prefer lower-risk investment options.
If you have the time to weather short-term variance in the market, you may be willing to accept a higher level of risk because there is the potential for a significantly higher return.
Inflation also plays a major role in your retirement savings strategy. You could take all of your money and bury it in the garden and, when you retire, you’ll have exactly that amount available. Inflation, however, means that the value of those dollars would have decreased. In order to counteract inflation, your investments need to be growing at or above the rate of inflation.
Seeing a return significantly higher than the rate of inflation will allow you to have more spending power in retirement – or, better, allow you to retire earlier!
A quick reference guide to risk and return
Risk labels (or risk profiles) are an easy way for you to understand the levels of risk across different options and across different funds.
On a fact sheet, you’ll see a box that looks like this:
|Risk band||Risk level||Estimated number 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|
Essentially, the risk label is defined by the number of years that a negative return (or loss) is expected over a rolling 20-year period.
For a low risk investment, it is estimated that the option will provide a negative returns in 1 year out of every 20. That roughly translates to a 5% chance of a “loss” in any given year.
For high risk investments, the chance of a negative return can increase to 6 out of every 20 years. So, in any year there is a 30% chance of a negative return.
This doesn’t mean, however, that if an investment option saw a loss last year that it will not produce a loss for the next 19 years. Likewise, if something has seen a negative return for 3 consecutive years that doesn’t mean that it will make a positive return the next year. This is a concept called the gambler’s fallacy.
Think about it like tossing a coin – if it comes up heads three consecutive times, the odds of it being heads on the next toss remain 50/50. Prior performance does not guarantee future returns.
What kind of risk should I take on?
Your individual goals for retirement should guide how acceptable you find risk. We offer our members 14 different investment options from extremely conservative to high-risk depending on a person’s needs.
Generally, if you have a long time to retirement (20 years or more) you may be willing to weather downturns and take advantage of the larger returns provided by higher-risk growth assets.
If you are trying to preserve your capital before retiring, you may want to adopt a more conservative, low-risk approach.
There are an overwhelming amount of variables between these two pillars, however. We offer our members several ways to review their situation and decide what kind of risk they are willing to take on and which investments they should select for their superannuation funds.
In order to help you decide which investments are right for you, we offer several ways to review your options including: