In this guide
Choosing investments with the potential to earn high returns sounds like a no-brainer, until you consider the risks.
That’s not to say risk is bad. All investments carry risk. Deciding on the level and type of risk you’re comfortable with is one of the fundamental steps to ensuring your super is working hard to produce the returns you need to fund your retirement, while also giving you the confidence to stick with your strategy through varying market conditions.
You might already have an idea of your personal tolerance for risk, but perhaps you’re not entirely sure of where your partner sits on the risk spectrum.
Either way, it’s a good idea to get a clear understanding of your individual and/or combined risk appetite and how that fits in with the range of investment options available when it comes to your super.
Rethinking risk
The first step to understanding your risk profile and taking control of your investment choice is to carefully consider the risks you are exposed to.
Investment risk is often described as a simple spectrum, with stable assets like cash and fixed interest carrying less risk, and more volatile assets like property and shares carrying more. This picture is accurate when you’re thinking about the risk of short-term loss, but the trade-off is that the more volatile assets provide a higher return in the long run.
When making investment decisions, it is critical to consider the whole picture. If you invested solely in ‘secure’ assets, you would be very unlikely to suffer significant short-term investment losses (or gains), but your investment would grow slowly. This increases the risk that your assets will not grow quickly enough to keep up with inflation (known as inflation risk) and the chance that your assets will not be sufficient to last for life after retirement (longevity risk).
On the other hand, if you invested solely in shares, property and alternative investments, your portfolio would have a high chance of sharp losses (and gains) in any one year, but the expected return after a long period would be significantly higher. Both inflation risk and longevity risk would be lower than a ‘secure’ portfolio.
This is what we call the risk/return trade-off.
Particularly when it comes to super, the risk that your balance doesn’t grow enough can be more important than the risk of making a loss in the short term. Super is, by nature, a long-term investment – for most of us it’s locked away until at least age 60 and then expected to provide income for life after retirement.
Because of the influence of time, the type of risk you’re happy to accept for your super may be very different from other investments.
For example, if you want to save a deposit to purchase a home in four years, you’re probably not willing to risk an investment loss that may take years to recover from. However, if you’re considering super that you’re not planning to access for another 20 years, a loss this year is less important.
You may be more than happy to accept that risk in exchange for a higher return in the long run, knowing your balance has time to recover losses and go on to reach new highs.
The Standard Risk Measure
Since June 2012, super funds have been required to include a risk rating for all their investment options. Called the Standard Risk Measure, the aim is to provide members with a simple but consistent means of comparing the risk of different investment options, both within and across super funds.
Risk is measured according to the likely number of negative annual returns over a 20-year period. The lower the number of estimated negative returns, the lower the score on a rating of 1 to 7.
For example, an investment option that fund trustees estimate is likely to produce a negative return less than 0.5 times in 20 years would be in risk band 1, while an investment option likely to produce a negative return less than one year in 20 but more than 0.5 times would be in risk band 2, and so on. You can see all seven risk bands with their estimated negative years in 20 outlined in the table below.
Standard Risk Measure
| Risk band | Risk label | Estimated number of negative annual returns over a 20-year period |
|---|---|---|
| 1 | Very low | Less than 0.5 |
| 2 | Low | 0.5 to less than 1 |
| 3 | Low to medium | 1 to less than 2 |
| 4 | Medium | 2 to less than 3 |
| 5 | Medium to high | 3 to less than 4 |
| 6 | High | 4 to less than 6 |
| 7 | Very high | 6 or greater |
Source: APRA
You can find the risk rating of investment options on your fund’s website, along with other details such as performance targets, actual past performance over different time periods, and asset allocation.
For MySuper options, the information is clearly set out on a single page called the ‘MySuper dashboard’, also available on your fund’s website.
Limitations of the Standard Risk Measure
SuperRatings executive director Kirby Rappell says that although the Standard Risk Measure gives investors a relatively simple way to understand how risky an option may be, it presents a couple of challenges.
“It doesn’t explain how large the negative return may be; a 2% fall or a 20% fall are quite different experiences in an investor’s mind. Secondly, there can be variations in the assumptions used by providers when calculating risk scores,” he says.
The Standard Risk Measure may also be undermined by a lack of consistency in the labels that funds give to their investment options. For example, UniSuper’s Balanced option is in risk band 6, indicating high risk. While over at QSuper, its Balanced option is in risk band 4, or medium risk, which is probably closer to the level of risk members might assume from a balanced asset mix.
Investment profiles
Whether you have a self-managed super fund (SMSF) or are in a retail, corporate or industry super fund, you will need to decide on an investment profile. For SMSFs, this will be included in your investment strategy, but if you join a larger fund, you will have a range of investing options.
Super funds now provide a vast range of options to members – some funds even offer the option of investing directly in shares and term deposits – but they will also include at least five or six pre-mixed investment options.
These pre-mixed options are generally defined by their allocation to growth assets and defensive assets. Equities (shares), commodities and private equity are considered growth assets. Cash and fixed interest (bonds) are considered traditional defensive assets. Property and infrastructure have both growth and income-generating properties, which leads them to be classified as mixed growth/defensive assets. Property and infrastructure can also be held in physical form or as listed securities, which have different risk profiles.
The following table is a rough guide to the kinds of investment profiles that you will be able to choose from, starting with the most aggressive risk profiles, tapering down to the most defensive.
| Risk profile | Percentage of growth assets | Percentage of defensive assets |
|---|---|---|
| High growth | 98% | 2% |
| Growth | 80% | 20% |
| Balanced | 70% | 30% |
| Moderate growth | 55% | 45% |
| Stable | 35% | 65% |
| Income plus | 30% | 70% |
The actual percentage of growth assets in each of the risk options can differ widely from fund to fund, so it’s important to check the actual asset allocations of any investment options you’re interested in.
Even then, two investment options with a similar percentage of growth assets can have a very different performance history, which comes down to the investment manager’s philosophy, style and expertise. Once again, it’s important to look at long-term performance of five years or more. Some investment approaches will flourish in certain market conditions and not others, so the top performers one year may lag the competition the next.
Knowing your risk profile and the risk/return profile of various investment options is very useful when choosing the most appropriate option for your super. Selecting an option closely aligned to your risk profile means you are more likely to feel comfortable with how your super is invested and less likely to panic during the normal market ups and downs.
Investing over your lifecycle
As your capacity for risk is likely to be different at different stages of your life, your investment profile and asset allocation should be reviewed periodically.
When you are young and have plenty of time to recoup any losses, you can afford to have larger allocations to riskier growth assets. But as you get older and more protective of your capital as you get closer to retirement, you may look to switch to a more conservative investment option with a higher allocation to defensive assets.
Even so, it’s still important to keep a reasonable amount of your super in growth assets in retirement so it continues to outpace inflation. Depending on your health, you could be retired for 20 years or more.
Am I in the right super fund and investment option?
When you review your risk profile and asset allocation, even if they are still appropriate, you may question whether your current investment option is providing the returns you need. This is the question we often ask ourselves when we see comparisons between super funds.
SuperGuide publishes lists of the top ten performing super and pension funds across five different risk categories and over one year and 10 years.
You can find descriptions of each category and links to the top 10 super lists by clicking the boxes below.
If your super fund doesn’t appear in the top 10, it doesn’t necessarily mean it hasn’t performed well over this timeframe.
Your super fund may still have met its investment objective by outperforming its identified target (usually exceeding inflation or a nominated benchmark by a stated degree).
See if your super fund at least met the median return for the same timeframe with investment options in the same risk category.
Additionally, you can check out SuperGuide’s comprehensive list of investment options and their quartile rankings over various timeframes.
If you conclude it’s time to reassess your fund or investment option, there’s no harm in exploring what else is available, but take your time to do so methodically and thoroughly.
The bottom line
Investing for retirement is not just about how much you can make before you retire, it is also about what level of risk you are comfortable with to get there and throughout your retirement. A healthy balance is obviously desirable but so is a good night’s sleep.
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