Risk & Returns
Volatility
Investment Time-frames
Risk
> Liquidity Risk
> Inflation Risk
> Regulatory Risk
> Strategy Risk
> Market Risk
> Asset Risk
Managing Risk
> Diversification across Asset Class
> Diversification within Asset Class
> Diversification within Management Styles
Reserves
What do I need to know about risk? In recent years we have seen extremes in market movements and investor behaviour. Market volatility and changes in investor sentiment go hand in hand and it is therefore important to understand some basic principles about risk and make realistic assumptions for long-term investment returns. The relationship between long term risk and return in different asset classes is illustrated in the following graph:
Matching Your Risk Profile with your Investment Objectives often involves coming to terms with competing desires for investment security and investment returns. This can be described as the risk return trade off.
The reason why we invest in higher risk growth investments is because of the potential for higher returns as the graph above demonstrates. Risk and return tend to be closely related and so by choosing a lower level risk investment or adopting a lower risk investor profile you are also choosing to reduce your longer term returns expectations.
With cash, term deposits and fixed interest investments, there is much greater certainty in the level of returns that can be expected and also much lower likelihood that there would be any erosion of your capital invested. Hence the level of risk is lower than with assets that are more unpredictable such as shares. Growth assets, although much more volatile with no certainty of a capital return in the short term, generally provide the investor with long-term capital growth, important to counter the effects of inflation and taxation.
Risk also must consider whether or not we are likely to achieve the goals that we have set ourselves within the time frame that has been established.
When choosing an investment option, you need to think carefully about how much money you will need in retirement and your level of contributions. We encourage you to seek expert advice and start planning for your retirement today. ACSuper has appointed Australian Christian Services (licensed dealers in securities AFSL 247388) to assist members with financial planning advice.
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Risk should not be confused with volatility. Volatility refers to the extent to which the values of your investments fluctuate over a period of time. The greater the volatility the more frequent the shifts. Shares for example, have a higher volatility than fixed interest and cash with prices changing daily and levels of income distribution changing as well. However, despite short-term unpredictability, the general trend of the volatile price movements in shares over the long term is upwards.
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Many investors, (often out of fear or naivety), try to predict market cycles and make short term speculative decisions in order to try and achieve superior returns. History has shown, however that the best way to invest is to consistently buy quality investments and to hold for the long term.
Having sufficient time in the market is an important consideration in selecting investments and strategy, as it not only affects your considerations prior to retirement but for your entire life expectancy. Short-term volatility is less important when we are focussed on achieving a long-term growth objective. Risk is dependent on the time frame that we set and generally decreases with time.
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Ease of Access to Funds – Cash Reserves
When considering an investment strategy, we must plan to maintain a cash reserve to access in case of emergencies and investment opportunities that arise. While cash does not provide a high return and no growth to counter the effects of inflation, it does form an integral part of any portfolio. As your super is typically not accessible prior to retirement, in making additional contributions to your Super account it is important to recognise the loss of liquidity for other short term cash-flow needs.
The risk that the purchasing power of your investment may not keep pace with inflation, which will occur if your investment is providing a net return less than the inflation rate.
The risk of government policy, regulatory or legislative changes, which could impact on taxation, social security, costs and reporting requirements. This risk may also apply to overseas investments as changes of policy determine whether funds can be withdrawn from an overseas country.
The risk an investment strategy may no longer be appropriate for you because of the impact of legislative and other changes on your personal or financial circumstances or objectives. This is why you should review your investments regularly.
This risk relates to events that may occur which have a negative effect on the price of all types of investments in a particular market, for example the stock market for shares or the bond market for fixed interest securities. Events that can influence markets include legal and economic policy, political activity, investor sentiment, technological development or failure, and world events.
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Asset risk is the risk inherent in each of the major asset classes offered within the Fund: shares, property, fixed interest and cash. It is important to understand the risks involved within each asset class as it will help in understanding the risk inherent in each investment option.
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- Shares
The risks of investing in shares include a decline in the value of your investment or a reduction in the income received. These risks may occur for a number of reasons, some of which include a change in the company’s operating environment or internal operations, poor management, and reduced profit expectations. Rising interest rates can also have a negative effect on share prices as increased borrowing costs by a company may cause profits to decline. Investments in international shares also face the additional risk of currency. This risk may occur with adverse movements in the exchange rate to reduce the Australian dollar value of international investments. For example, if shares in an American company are purchased and then the Australian dollar rises relative to the American dollar then the value of those shares may decrease.
- Property
The risks of investing in property include a decline in the value of your investment and/or a reduction in the income received. This may occur for a number of reasons including, market supply, unexpected loss of tenants, changing rental rates, poor management, and rising interest rates.
- Fixed Interest
Investments into fixed interest assets may result in a reduction of income and/or a fall in the value of your investment. These outcomes may occur if an issuer of a security cannot meet their repayment obligations or repay the initial principal invested. The value of fixed interest securities can also fall when interest rates rise. Investments into world fixed interest markets may also face the additional risk of adverse currency movements.
- Cash
Investments into cash are considered the least risky of all asset classes. The potential of a reduction in income and/or capital value is very low, however these outcomes may occur if the issuer of a security is unable to meet their repayment obligations or repay the initial principal invested.
Diversification is a basic principle of prudent financial management. The old adage of “don’t put all your eggs in one basket” has proven to be true in the light of history. There are three basic forms of diversification that you should be aware of in selecting your investment options:
Investments can be placed in the four major asset classes: shares, property, fixed interest (such as term deposits and bonds), and cash. When you spread your investments across these areas, you are able to take advantage of upturns in one asset class while avoiding over exposure to any one area during periods of poor performance.
Cash and fixed interest investments generally provide a highly certain level of income and preservation of capital. These are generally called defensive asset investments for this reason. The performance of these asset classes over time however, has historically not been as high as the other asset classes.
Shares are able to generate higher returns in the long term, but their performance from year to year can be volatile. Property has historically provided returns somewhere in the middle -not as volatile as shares but with better returns than cash and fixed interest. Shares and property investments are generally called growth or aggressive asset investments.
For most investors, some exposure to all four asset classes is appropriate. The area that is emphasised is determined by the likely period of time the investment will be held, the investor’s particular income and growth needs, and the amount of volatility an investor can tolerate.
Whilst shares and property are riskier than cash and fixed interest in the short term, they should provide greater protection against inflation in the longer term due to the prospect of income growth and therefore capital growth.
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Investments within any asset class can be diversified by geographic location, industry, and nature of the security itself. For example, when investing in shares, it is prudent to recognise that the Australian share market is barely 2% of the world market and for this reason, share investments without any exposure to international holdings, constitutes a higher non-diversified risk. A diversified share portfolio would generally include a minimum of 20 stocks with exposure to different size companies and different sectors; e.g. banking, resources, industrials etc.
Different fund managers have varying investment styles and perform differently during changing economic conditions of the investment cycle. For this reason, more than one fund manager is normally recommended to provide diversification for portfolios of greater than $50,000. Diversification is important not only across asset classes but across funds themselves.
ACSuper currently utilises over 30 investment managers (see page 15 of the Member Booklet - PDS) and achieves an excellent diversification of style bias within each asset class. For more information on manager’s investment styles contact Australian Christian Services Financial Planning on 1800 646 777.
ACSuper does not provide reserves for the purpose of investment fluctuations.
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