When you’re exploring your investment choices it’s important to understand risk, and your personal appetite for it. Many people associate risk with the chance of losing money – making it something they avoid at all costs. In reality, not taking risks can lead to lost opportunities when it comes to returns on investment.
Here are 4 of the most common myths and misconceptions about investment risk:
Myth 1: Shares are too risky
The nature of risk changes depending on how long you can invest. In the short-term (up to 5 years) the biggest risk comes from market volatility – uncertain market conditions. For example, if a downturn occurs your investments may not have enough time to recover.
This is the type of risk that many investors dwell on. However, avoiding this type of risk often comes at a cost: lower returns.
AustralianSuper's Cash investment option is a very low-risk choice. It isn’t expected to deliver negative returns. However, over the 5 years to June 30, 2019, its average return was just 2.09% a year.
On the other hand, the Australian Shares investment option is exposed to a higher level of market volatility. It’s expected to deliver negative returns in about 5 of every 20 years. That’s A 30% chance of a negative return each year. Over the same 5-year period, the Australian Shares investment option delivered an average return of 9.47% a year – more than 4 times higher than the Cash option. So, taking on this level of risk could deliver the potential of higher returns.
Myth 2: Cash is a low risk choice
Cash is a safe investment that provides portfolio stability, but that comes at the expense of lower returns. Saving for retirement typically involves investing for the long-term, and that means periods of lower and higher returns – however, portfolios that include more growth assets tend to perform better over time.
If you plan to invest for more than 20 years, focusing on the long-term allows you to invest in assets that offer the chance of higher returns.
Moving to cash to avoid short-term market volatility can negatively impact portfolio return when the markets rise after a downturn. History shows us that markets have rebounded from downturns, making short-term market volatility a minor disruption to long-term performance.
Growth assets, such as shares, can increase in value quickly after a downturn - so missing a few days of positive performance can have a negative effect on your long-term returns.
Importantly, the low returns of cash also make it difficult for your investment return to keep pace with inflation. If the price of goods and services rise at a higher rate than the return on your cash, you won’t be able to buy as much in the future.
Myth 3: We need to avoid investment risk as we get older
Another risk you face over the long-term is longevity risk - the chance that you'll run out of money thanks to the fact we’re living longer than ever before. While the Government Age Pension provides an important safety net, many retirees aim for a more comfortable lifestyle than the pension alone can provide.
Funding that lifestyle requires investing in higher-returning growth assets, but many people gravitate to less volatile investments as they grow older. That’s due to loss aversion, a common behavioural bias that makes the expected pain of a loss outweigh the benefits that higher returns would provide.
According to government data, the average retiree aged 65 is likely to live for around another 2 decades. This means it can pay to continue investing an appropriate amount in growth assets.
Myth 4: Volatility is the only risk
The nature of risk changes when you’re investing over a longer period of time. While volatility is still something to be mindful of over the medium term (5–20 years), the impact of inflation is also a risk to consider.
Inflation risk refers to the impact of price rises over time on the purchasing power of your money. If your savings or wages don't rise to match or outpace those price increases, your quality of living will decrease.
While inflation has been low in recent years, it can have a big impact in the long run. According to the Australian Bureau of Statistics, the price of a loaf of bread rose from the equivalent of about 2 cents in 1901 to about $2.30 in 2001.
While market volatility is an obvious risk, the impact of inflation is less visible. The face value of $100 in your pocket stays the same but, in reality, it’s worth less over time as prices rise. Consider that a $4 takeaway coffee today could cost $8.40 in 30 years if inflation rises by 2.5% per year.
This is why it's crucial to take on the right level of investment risk - to generate higher potential returns and offset the gradual erosion in wealth resulting from inflation.
AustralianSuper's Balanced investment option aims to outpace inflation as measured by the Consumer Price Index (CPI) by more than 4% a year over the medium to longer term. It does this by investing in a wide array of diversified assets, which are actively managed to maximise returns over the long-term.
Managing your risk strategy
To work out the right level of risk for you, it’s important to consider factors such as - how much you’ve saved, how much money you’re planning to withdraw and your investment timeframe.
Risk is a normal part of investing. When managed as part of an appropriate strategy aligned with your goals - there's nothing to fear.
Do you have questions about investment and risk?
For personal advice on your investment options, super and retirement planning - at any stage of your life - consider speaking to an AustralianSuper adviser.
This information may be general financial advice which doesn’t take into account your personal objectives, situation or needs. Before making a decision about AustralianSuper, you should think about your financial requirements and refer to the relevant Product Disclosure Statement. AustralianSuper Pty Ltd ABN 94 006 457 987, AFSL 233788, Trustee of AustralianSuper ABN 65 714 394 898.