KiwiSaver is an investment. And with all investing, comes risk. We've explained here what these risks are and how to minimise them.
Market risk is based on the overall economic conditions of the country – and even the world. Changes in market factors are unpredictable and impossible to avoid. For example, when the stock market crashed amid the COVID19 pandemic, many investors saw the short term value of their investments plummet. Even though the quality of most of their investments didn’t change, the performance of those investments were affected by events happening in the market. Market risk consists of some of the following types of risk:
Equity Risk: The risk of holding shares rather than bonds and the risk that share prices will go up and down.
Interest Rate Risk: The risk that comes from an increase or decrease in interest rates. When interest rates rise, consumers and businesses cut back on spending, resulting in earnings and stock prices to fall.
Currency Risk: The risk that exchange rates will go up or down. Currency risk can affect investments in a foreign company or domestic company that has suppliers or customers in other countries.
Diversifiable risks are those which are unique to individual stocks, businesses, industries, or countries. As the name implies, diversifiable risk is risk that can be reduced by diversifying your investments. By not ‘putting all your eggs in one basket’, you can reduce the risk of breaking all your eggs when you drop the basket. There are many types of diversifiable risk, here are some examples:
Business Risk: The risk related to the uncertainty of income streams from companies.
Financial Risk: The risk that a firm’s financial structure will negatively affect the value of the investment. An example is if a company’s cash flow cannot cover their debts.
Political risk: The risk that the politics or economy of a country can impact investments. Examples include trade barriers, taxes, and legislation.
Investment manager risk: The risk from mistakes, negligence, and incompetence of investment managers that can lead to losses. It also includes changes in the investment style or the change in management.
Volatility is the short term movements of the markets and particular stocks or investments. This movement can be caused due to various reasons such as a market event, some 'breaking news' or sometimes even due to irrational trading in the market.
Volatility risk comes when you are forced to sell your investments when they are at a low because your personal situation means you need to withdraw money from your investment now. Examples of this could be you are retiring or need money for a first home.
Volatility Risk is a risk you can avoid or at least try to manage.
How do I minimise these risks when investing?
With risk coming in from all directions, how can we minimise the risk our investments are exposed to?
Unfortunately, market risk is unavoidable as no one has a crystal ball to see into the future. However, market risk typically only leads to volatility rather than real capital loss since it is priced into the market. The large dips in the overall market are more often than not short term. So as long as you are in the correct type of investments for your own personal situation, market risk should not affect your long term goals.
Diversifiable risk can be minimised by having a diversified portfolio of investments. You can also minimise risk by investing in low-risk investments such as fixed interest securities. Additionally, by closely monitoring your investments, you don’t miss any red flags like unethical or controversial business practices or scammers.
As an investor, your investments should be aligned with your investing time horizon, investment goals, income, and the level of comfort you have to volatility. Therefore, your KiwiSaver fund type should be based on not only how much volatility you are willing to endure, but more importantly, how much volatility you can endure based on when you will be withdrawing your KiwiSaver funds. The chart below shows the general relationship between volatility and returns.
How do you decide how much risk to take?
Before we answer that question, it's important to understand the difference between capital loss risk and volatility. Capital loss risk is the risk of losing the initial amount you invested and being unable to recover the lost amount. Volatility is the short term movements of the markets and particular stocks or investments.
These are two very different things. Unfortunately they are used interchangeably when people ( even some financial advisers) speak about investing.
We believe investors should completely minimize the risk of losing their capital, irrespective of their life stage and circumstances. The number one rule of investing is never lose money. We can do that via diversification and doing good research into the companies/funds we are investing in.
However, the level of volatility an investor should accept is a totally different matter. By accepting too little or too much volatility, you may not be able to maximise your KiwiSaver account for your retirement or first home outcomes.
If you are too conservative with your investing, it may make it more difficult for you to reach your financial goals or retirement lump sum goals. On the other hand, if you go too high on the volatility spectrum relative to your risk capacity, you could end up with a fallen balance when it comes to withdrawing your KiwiSaver funds.
How can National Capital help?
We are financial advisers at National Capital, and we help our clients pick the right KiwiSaver strategy for them, so they can minimize all the above risks. We do that by understanding what your personal circumstances and goals are, and then recommending a fund or funds that suit those circumstances and goals. As part of our recommendations, we do the following...
Detailed Research: Our research team looks into various factors of 100+ KiwiSaver funds – from asset allocation all the way to ethical investing.
Answers: How do I know my money is safe? What risks are being taken?
Monitoring: We’re constantly monitoring the KiwiSaver landscape.
Expertise: Our team specialise in Investment and KiwiSaver research.
No cost to you: We get paid by the KiwiSaver providers
Gift of Time: We do the hard work, so you can focus on life.
Our KiwiSaver recommendations look at the big picture and not just the scorecard. Take the KiwiSaver HealthCheck now and let us minimise your risks while maximising your returns.