BNZ offers tips: How to gauge investment risk and return.
Risk is an inherent part of investing and typically, the higher the risk, the higher the potential reward. There are some key factors to help you decide what type of investment suits you.
Defining investment risk
Investment risk can be described as “the chance that you end up with a return that’s different to the return that you expect”. This is a definition that has stuck with Ryan Wilson, BNZ’s General Manager Wealth & Insurance Partnerships, who suggests “you can think of the return you get as being the reward for the investment risk that you’re taking on”.
For higher risk investments, we generally expect higher returns over the longer term, but larger changes in return from one year to the next. They’re generally for those who have the ability and investment tolerance to leave their money in the market longer, and not sell assets when the market is down and crystallise a loss.
For lower risk investments, typically one expects to have lower levels of return over time.
Wilson says there are three main elements to consider when working out what suits you:
· your personal investment goals
· your investment timeframe
· your tolerance for risk
Investment goals help you make decisions and guide your investment timeframes. They might be shorter term goals like a trip or longer term like saving for future education costs. The further in the future your goal, the longer you can leave your money in the market to grow.
Your tolerance to risk is how comfortable you are with the way the ups and downs of the markets will change the value of your investment along the way.
Wilson says a good question to ask is, “if the value of your investment went down 10%, how would it make you feel?” If the result would be sleepless nights, and a panic sale of shares when the market is low, a lower risk investment might be a better choice for you.
How do I mitigate risk?
The key to mitigating investment risk is diversification – investing in a range of different things so you’re not exposed to just one investment and its fluctuations.
This can be diversification across a range of countries or asset classes (for example cash, bonds and shares), to minimise your exposure to the same market cycles, or investing in a range of things in one asset class (for example various different shares).
The key is to create a diversified portfolio to give yourself more of an opportunity to experience the positive side of investment risk.
Seeking professional advice can also help with risk mitigation and decision making. There is plenty of publicly available information including on managed funds and KiwiSaver. Financial advisors can also give you targeted advice around choosing the right investment approach for you.
When to say no or sell up – how much risk is too much risk?
“For a potential investment, if it seems too good to be true and you’re being promised very high returns for very low levels of risk, then you have to be very cautious,” says Wilson.
He says it’s also important to look at investment and risk in terms of having time in the market rather than trying to time the market, with market highs and lows notoriously difficult to predict.
Choose an investment that has a level of risk that’s aligned with your goals, your investment timeframe and your risk tolerance and wait out those market cycles.
The exception to that is if changes in your personal circumstances mean that your investment goals, investment timeframe or risk tolerance have changed – if that happens you might need to make changes to how much risk you’re taking in your investments.
Wilson also says checking in regularly with your investment makes sense, as long as you keep your goals front of mind when you do.
“This is part of learning and understanding how the markets work and how your investment works. Just keep your goal in mind so that you’re not going to be too focused on or reactive to short term market movements.”
This content is sponsored by BNZ.
This article is solely for information purposes. It’s not financial or other professional advice. For help, please contact BNZ or your professional adviser. No party, including BNZ, is liable for direct or indirect loss or damage resulting from the content of this article. Any opinions in this article are not necessarily shared by BNZ or anyone else.