You can’t escape investment risk, not even when it comes to KiwiSaver. No matter what someone on the internet tries to sell you, there is no such thing as a risk-free investment.
If you are looking at an investment with no apparent risk, that just means you haven’t seen it yet. Like tossing a coin that comes up heads five times in a row, there is no evidence that it could come up tails. I’m 56 years of age and based on my track record of not dying for over 20,000 days in a row, it appears that I am immortal.
But it would be unwise to place all your money on a bet that the coin will never come up tails (or that I am immortal) based on what you’ve seen, right?
So if you can’t see investment risk, how do you gauge it? As an investment professional, I talk about risk all the time; it’s a topic I am comfortable with. But for many people it is a concept that needs some explaining.
What kinds of risks do investments carry? How can you manage your investment risk to a level you are comfortable with? How is risk involved with your KiwiSaver fund?
Understanding risk
An adviser may recommend some investments as safer than others but there is always a risk. Money in the bank is ‘safe,’ but banks can and do go bust. Government bonds are ‘safe,’ but governments can and do go bust. There are no guarantees - every investment has risk.
What investors search for is the most return for the least risk. This search is a global competition with trillions of dollars at play, which is good because competition results in an equilibrium between risk and return.
Here’s a basic chart to illustrate the investment risk and return equilibrium:
The purple line represents the fair price at which buyers and sellers can trade an investment. The line acts like a magnet, drawing all investment towards it.
Investment A represents the dream investment - high returns and low risk. Everyone wants it and will pay a high price for it. People who own it won’t want to sell it - unless the price is very attractive. But at some point, the price cannot keep rising because it will outweigh the returns, drawing it back towards the blue line.
Investment B is just the opposite. It presents a high risk with little return. No one will buy this until either the price falls or the returns rise to a more equitable level.
Ultimately all investments available anywhere on the planet will be honed through competition and align close to the blue line. It is a hot competition and investors exploit advantages at the fraction of a cent to create a profit.
Thankfully, unless you are an investor with direct access to the markets, you don’t have to worry about your risk day-by-day on a global scale. That’s way more stress than any of us need.
Managing risk for retail investors
What we call ‘retail investors’ are people who are not industry insiders. We’re not spending our days worrying about fractions of cents at play in the global finance industry. But that doesn’t mean we can ignore risk, especially when online platforms make it easier than ever to start investing.
So what kind of investment risk do you need to be concerned with? It falls into two categories: market risk and concentration risk.
Market risk
Market risk refers to the rise and fall of markets in general. We know that assets like shares and property tend to rise in value over time and that this rise usually exceeds the cost of living over time. This is why we invest - to watch our money grow in time.
Concentration risk
This is where we can get caught out. Concentration risk results from having too many eggs in one basket - a lack of diversification. There is a certain appeal to concentration risk. We hear of the success stories of those who got the BIG WIN. Elon Musk, Jeff Bezos, Mark Zuckerberg - concentration risk paid off for them. As appealing as it sounds, it is highly unlikely for the level of risk to pay off sufficient reward.
Closer to home, Kiwis have a concentration risk tied to our local economy - we earn our income here, pay taxes, and hold most of our assets in NZ. What can we do to mitigate our risk?
How to manage market risk without concentration risk
Diversify, diversify, diversify.
Rather than a single investment or even a few investments, hold small pieces of many investments. These small pieces together are called a portfolio. Each small piece is different from the next - they are diverse. This mitigates risk because if one area doesn’t perform well, it is balanced by other investments.
A globally diversified portfolio is your best option to get a good return from the market without concentration risk.
Elon, Jeff, and Mark would do well to take such advice - in fact, they have (they’re no dummies). From time to time, they (and other rich listers) have sold significant chunks of their shares and diversified their investments by buying real estate, businesses, and other assets. Even Elon’s plan to buy Twitter would have diversified from car manufacturing.
Risk and your KiwiSaver fund
How does risk play into your KiwiSaver fund? KiwiSaver funds are categorized based on risk level. From low risk to high risk, these are defensive, conservative, balanced, growth, and aggressive. This allows you to customize the level of risk you are comfortable with when you choose a KiwiSaver fund.
All conservative, balanced, and growth funds are diversified portfolios designed to protect and grow your wealth in an uncertain world. To determine which KiwiSaver fund is best suited to your circumstances, take our five-minute Fund Finder quiz - we will match you to a fund based on your goals, timeline, values, and risk tolerance.
We are here for you to check in any time to assess the risk level of your KiwiSaver and help you switch funds if your circumstances indicate it is a wise move. You can take the quiz at any time or get in touch at [email protected] or give us a call on 09 320 1550. No one makes managing your KiwiSaver fund easier than us.