Do you like to skydive, but you freak out if you see a decrease of $1,000 in your KiwiSaver value? Do you fear the money is gone for good?
Do you like to stay firmly on the ground, but it doesn’t bother you to see your KiwiSaver balance drop by $10,000? Are you confident that it will bounce back up when the markets recover, even if that might take a while?
The risks you are happy to take in life don’t always equal the risks you can cope with for your savings. Everyone has their own level of comfort, or what is known as their ‘risk tolerance’, when choosing the KiwiSaver investment choice that is right for them.
In our latest blog, we delve a little deeper into the risks we face when we invest our money.
When we think about risk and investing, there are a few fundamental truths.
- We only ‘lose’ money when we take money out of our investments – Like owning a home, we only gain money when we sell the house for more than we paid, and we lose money if that value is lower. The same applies to our investments. The fall in value is not ‘real’ until we withdraw our money from that investment.
We hope that in the long term, the value of our house and investments go up. In the meantime, changes in those values are simply numbers on a page.
- Volatility is the risk we care about – Volatility is the measure of how much our investment rises and falls in value over a period of time. For example, an investment that rises and falls by 5%, has a much lower volatility than one that moves up and down by 40%. The second one carries a higher degree of risk—especially if we need to start withdrawing funds from the investment in the near future.
If our investment is worth $100,000 and drops to $95,000 we might be comfortable, because this only needs to rise by just over 5.25%, to recover. However, if this falls by 40% to $60,000, that could be a lot scarier. We would have to see a rise of over 66%, just to get back to the $100,000 again. Can the investment do that, and can our nerves handle the ride?
When thinking about our risk tolerance, we consider how much volatility or uncertainty we can bear, before we start having sleepless nights.
- Diversification matters – Putting all our money on one stock is what we term ‘putting all of our eggs in one basket’ and is a risky strategy with our life savings. That is why we want to spread this around, to investments that move differently over different market cycles. Good diversification reduces the risk of losing our money.
- Perception is not always reality – You may know the saying ‘this too shall pass’.
Markets will always move up and down and our investment balances will follow. The trick is to understand that what we see happening in our investments today is only a snapshot in time. What matters more is how our investments behave over the long term, i.e., over more than seven years. Our perception is not always the reality and while we may have short-term uncertainty, we can still have a good long-term investment.
So, the next time you are looking at your investment options, remember the four fundamentals:
- Your risk tolerance is what you are comfortable with over the long term.
- What is happening in the markets today, might not represent the future.
- Diversification matters.
- The highest return is not always the best, if this comes at the cost of too much risk.
Focus instead on the goals you wish to achieve and choose the investment that can achieve those goals.
*Nothing in this blog constitutes personal financial advice nor a guarantee of success when investing. We recommend you seek independent professional advice, prior to investing your money.
