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The reality is, when you’re saving for your retirement, you’re exposed to a range of different risks that can affect your investment returns and how much money you end up having in your super account when you decide to finish working.
We look at 9 investment risks and the impact they can have on your retirement nest egg.
While investing always goes hand-in-hand with risk, the particular risks your super account is exposed to vary depending on the underlying assets. Not every investment risk applies to every asset, or applies all the time:
1. Market risk
This is the risk that your investment will decline in value due to economic developments or other events affecting the entire investment market. Market risk covers things like:
- Changes in domestic and international economic conditions (like a recession or boom)
- Government policy changes (a decision to impose tariffs or change the laws regulating a particular market)
- Rising or falling currency exchange rates (may make the value of your overseas investments worth less in Australian dollar terms)
- Shifts in interest rates (the RBA or central banks lifting or dropping rates)
- Changes in market sentiment (like the sharemarket becoming more ‘bearish’).
When market events occur, they can have a significant impact on the assets your super fund has invested in. For example, tighter economic conditions may make your share investments worth less due to the expectation companies will find it tougher to make money.
Another example is changes in interest rates, which can reduce the value of bonds and fixed interest assets. This is because the market value of a particular bond your fund owns may decline if official interest rates rise.
2. Liquidity risk
This is the risk you can’t sell your asset at a fair price when you want to exit your investment. You may need to sell your asset at a lower price if you want to get your money.
In some situations, it may not be possible to sell the investment at all. This was the position some investors found themselves in during the GFC when certain asset markets became ‘illiquid’ – or without buyers.
For a super fund, a lack of market liquidity makes it difficult to sell its investment assets or raise sufficient money to meet its commitments to fund members at a particular point in time.
3. Concentration risk
This is the risk of losing money because your portfolio concentrates too much on one particular asset or class of investments.
For example, if the majority of your SMSF’s assets are invested in a single investment property or a small number of Australian shares, you face significant concentration risk, as your portfolio is not diversified over a range of asset classes, industries and geographic locations.
4. Credit risk
This is the risk a bond issuer will run into financial difficulties and will not be able to fulfil its contractual obligation to pay the promised interest, or repay the loan amount (principal) at maturity.
Bond issuers include governments, a government agency and companies. If they fail to meet their obligation, there’s a financial loss to your super fund.
The level of credit risk is denoted by the credit rating of the bond. For example, a 10-year Australian Government bond has a credit rating of AAA, which is the lowest possible credit risk.
5. Reinvestment risk
This is the risk an investor faces when it comes time to reinvest their principal or income and the interest rates on offer are lower than previously available. For example, if your super fund has invested in a bond paying a 5% return, when the bond matures and the fund looks to reinvest, it may only be able to find bonds offering a 3.5% return.
Reinvestment risk is something many investors are familiar with at the moment when it comes to term deposit investments, as the rates on offer now are much lower than those in recent years.
6. Inflation risk
This is the risk you face when the value of an investment is not keeping up with inflation.
Rising inflation is a significant risk if you’re invested in cash or bonds, as the investment return from these asset classes tends to be more stable. Shares and property on the other hand, offer some protection against rising inflation as companies and landlords can increase their prices or rents.
7. Horizon risk
This is the risk your investment horizon – or time you have to invest – may be shortened due to an unforeseen event such as, becoming ill or losing your job.
In this situation, you could be forced to sell an asset you were expecting to own for a longer period at a loss. An example is being forced to sell the geared shares in your super fund during a market slump because you’re unable to meet a margin call.
8. Overseas (or country) investment risk
This is the risk you face when you invest in offshore assets.
Investments outside Australia are exposed to risks that may not apply at home. For example, when you buy shares in companies in emerging market countries there is a risk the government could decide to nationalise the company or industry. Offshore investments also face different economic conditions and different regulations.
9. Investment management risk
This is the risk that comes with using an investment manager – even when that investment manager is you.
Although investment managers try to understand and manage all the various risks that come with investing, they don’t always get it right. There’s a risk the manager – or you – will not do as well as the broader investment market. Which means you have lost money compared to what you could have achieved from investing with another manager.