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Want to add thousands to the account balance of your super when you retire?
Then make sure the investment option you have selected for your super account matches your risk profile, as that single decision can make thousands of dollars difference to your eventual retirement savings.
Don’t know what a risk profile is? Then read on to find out what one is and why it’s the key to one of the most important decisions you can make when it comes to boosting your super account.
What is risk tolerance?
Understanding your tolerance for financial risk and how it influences the investments you are comfortable with is very important. When it comes to investing, some people find themselves tossing and turning in bed, while others sleep easy.
Your risk tolerance is how emotionally comfortable you are with taking financial risk. Some people are natural risk-takers; others are not. Some people are very comfortable placing their money into higher risk investments (so they have the opportunity to generate a higher return), while others are more conservative and cannot stand the thought of losing money. Neither investment choice is right or wrong; it just needs to be the right one for you.
How you feel about financial risk depends on factors such as your:
- Personal goals
- Financial position
- Investment experience
- Investment goals
- Timeframe for investing
- Comfort with volatility
What is a risk profile and how is it determined?
A risk profile is a simple tool used to categorise where you fit on the risk-taking spectrum.
The aim of a risk profile is to identify the level of risk you are willing to take, which then determines the best allocation of investment assets given your risk tolerance.
Financial advisers use tools like detailed questionnaires, lifecycle analysis and sensitivity analysis to place you into a specific risk profile category. They ask you to choose from a range of answers in response to questions like:
- What is your major investment objective? For example, maintain the security of my investments with regular income to live on, or maximise the growth of my investments.
- How would you react if your investments declined in value by 20% in one year? For example, withdraw all my money immediately and move it to bank deposits, or increase the amount invested because the market is cheaper.
Once the financial adviser identifies your attitude to risk, they can then determine how much of each asset class (such as shares, term deposits or bonds) should be used when creating your investment portfolio.
Good to know
For more information on financial advisers, read SuperGuide articles:
- What happens when you meet with a financial adviser?
- What are the different types of financial advice available?
- Super advice: How to find a suitable financial adviser
Need to know
How your risk profile affects your super
Your tolerance for risk has a significant impact on your super.
Being in the right super investment option for your risk profile is one of the key factors determining how much you have when you retire, as shown in this case study:
Ayumi is aged 25 and is currently earning $80,000 a year. She has a $20,000 balance in her super fund account, which is defined by ASIC as a ‘low fee’ fund. Her employer is making the required 9.5% Superannuation Guarantee (SG) contribution.
Ayumi has selected the fund’s Conservative investment option for her super account and her super savings remain in this option until she leaves the workforce.
On her retirement at age 67, Ayumi has $349,250 in her super account.
If Ayumi had selected the fund’s High Growth investment option and left her account balance in this option, she would have $468,703 in her account at retirement – a difference of $119,453.
Figures calculated using ASIC’s MoneySmart Superannuation Calculator.
When it comes to selecting the right investment option for your super account, understanding your risk profile comes in very handy. Your risk profile helps you identify where you sit on the investment risk-taking spectrum and you can then match this to the appropriate investment option.
Super funds usually offer a selection of pre-mixed investment options ranging from conservative through to aggressive, growth-style investment options. This assortment means you can choose one closely matching your tolerance for financial risk.
Detailed information about the risk level, suitable investment time period and type of investor best suited to each investment options is available in your fund’s Investment Choice brochure, or by phoning the fund’s member information line.
Good to know
Super fund risk profiles: What they look like
There are no standard risk profiles or categories used across the investment industry, but different risk profiles are usually matched to common combinations of the major asset classes.
The investment mixes are based on percentages allocated to ‘growth’ assets (broadly shares and property) relative to ‘defensive’ assets (broadly cash and fixed interest).
Super funds usually offer investment options mirroring the standard combinations of defensive and growth assets listed below:
Common allocation split for defensive and growth assets
Description of suitable investor
95–100% defensive assets
Not prepared to take any investment risk and willing to sacrifice higher returns to safeguard capital.
70–90% defensive assets
10–30% growth assets
Prepared to accept only a small amount of risk. Priority is to preserve capital over the medium to long term.
50–60% defensive assets
40–50% growth assets
Can accept some short-term risk to capital to achieve longer term capital gain.
30–40% defensive assets
60–70% growth assets
Seeks consistent capital growth with some income to smooth returns. Suited to medium to long term timeframe.
15–25% defensive assets
75–85% growth assets
Understands investment market moves and is happy to sacrifice short-term safety to maximise long-term capital growth.
95–100% growth assets
Strong emphasis on maximising long-term capital growth. Able to handle short-term fluctuations in values and greater chance of capital loss.
Source: Table compiled by the author based on common profiles and asset allocations used by various super funds and investment companies.
For more information…
Learn more about risk in these SuperGuide articles:
- 7 ways your super fund manages investment risks
- 9 investment risks and how they can affect your super
- 5 ways sequencing risk affects your retirement
- Risk and returns: Getting the balance right
- Risk profiling and your investment choice
- Longevity risk: How deferred annuities can help your savings last as long as you do
Learn more about super fund investment options in the following SuperGuide articles: