All investments have some form of risk associated with them – they all expose you to the chance you could lose money (either notionally or permanently). In this Fact Sheet we discuss seven of the more common types of investment risk.
The risk of permanent loss of capital
Poor quality investments usually experience falls in their value from which they never recover. In extreme cases, their value can fall to zero.
The risk of volatility
Investment volatility is the risk of the value of your investment moving up and down. With high quality investments, their values should move up more than they go down.
Investments which are expected to produce higher long term returns (such as shares) tend to experience higher levels of short term volatility.
On the other hand, investments which are expected to generate lower long term returns (such as bonds) usually experience less volatility in the short term.
This can be seen in the charts on page 1 which show the range of historical returns (after subtracting inflation) for various asset classes over various timeframes, as well as their long term average returns. As you can see, the longer you hold your investments the less they are affected by volatility. For example, the range of returns for Australian shares in any single year has been -42.6% to 58.2%. However, the range for 10-year periods has been 2.9% to 14.6% p.a.
NOTE: Investors who redeem their investments after a fall in value turn a notional loss into a permanent loss. If they are high quality investments, this is usually a poor decision, because high quality investments should recover from falls in value.
This is where your investments do not generate sufficient returns to help you achieve your wealth or retirement objectives. This is typically the case when a person chooses not to employ an asset allocation which has a higher level of investment volatility (and also a potentially higher return). In that case, the person will need to lower their wealth or retirement expectations.
Credit risk usually applies to fixed term investments and means that the institution you have invested with may not be able to make the required interest payments or repay your money.
This is where your money loses purchasing power because your investments do not keep pace with inflation. Cash is one investment which usually falls prey to inflation risk.
Investments which are fixed term expose you to liquidity risk. For example, if you need to access your money from fixed term investments before the term expires, you may be prevented from doing so under the contract. Or, if you can access your money, it might take longer than you want, and/or you may be charged significant penalty fees.
Poor quality share and property investments also expose you to liquidity risk. The risk is that no one will want to buy them from you or will only buy them at a substantial discount.
When you invest overseas, your money is usually converted to the currency of the country in which you invest. If the Australian dollar subsequently rises in value compared to the other country’s currency, your investment will be worth less to you. On the other hand, if our dollar falls in value, your investment will be worth more.
How can you manage investment risk?
Investment risk can be managed using three prudent principles of investing:
- Only invest in high quality investments
- Construct a properly diversified portfolio
- Regularly review your investments to ensure they continue to maintain their quality.
Call Invest4Life on (07) 5456 1355 to discuss investments with our Financial Advisers.
Disclaimer: This information has been produced by Australian Unity Personal Financial Services Ltd (‘AUPFS’) ABN 26 098 725 145, of 114 Albert Road, South Melbourne, VIC 3205, AFSL & Australian Credit Licence 234459. Any advice in this document is general advice only and does not take into account the objectives, financial situation or needs of any particular person. It does not represent legal, tax, or personal advice and should not be relied on as such. You should obtain financial advice relevant to your circumstances before making investment decisions. AUPFS is a registered tax (financial) adviser and any reference to tax advice contained in this document is incidental to the general financial advice it may contain. You should seek specialist advice from a tax professional to confirm the impact of this advice on your overall tax position. Nothing in this document represents an offer or solicitation in relation to securities or investments in any jurisdiction. Where a particular financial product is mentioned, you should consider the Product Disclosure Statement before making any decisions in relation to the product and we make no guarantees regarding future performance or in relation to any particular outcome. Whilst every care has been taken in the preparation of this information, it may not remain current after the date of publication and AUPFS and its related bodies corporate make no representation as to its accuracy or completeness. Published: February 2017 © Copyright 2017