This article was published on 8 September 2012. Some information may be out of date.

Risk is not a dirty word

A man on the radio the other day was talking about risk, and how we’ve become so scared about our children’s safety that we don’t let them climb trees. The kids lose out. It’s similar with investments. Many New Zealanders seem to be too scared of riskier investments, and they too lose from that fear.

This past week, the Reserve Bank has published a free 64-page booklet I wrote for them called “Upside, downside — a guide to risk for savers and investors.” It’s about the different types of risks people take, and how to reduce or avoid them. Each section includes a bit about how that type of risk applies to KiwiSaver.

First, though, there’s a section titled “Risk is not a dirty word”. The following is an excerpt from that section:

Higher risk investments tend to bring in higher returns — basically because nobody would be prepared to take on the extra risk if they didn’t expect to be rewarded for it.

Investing in shares, for instance, tends to be riskier than investing in property. And — despite recent history in New Zealand — returns on shares in most countries over most periods are higher than returns on property, which in turn are higher than returns on high-quality bonds.

Note, too, that fairly small differences in returns can make a big difference over a long period. Let’s say, for example, that shares have a long-term average annual return of 8 per cent, while for property it’s 7 per cent and for bonds it’s 6 per cent. Over 30 years:

  • $100,000 in shares at 8% would grow to a little more than $1 million.
  • $100,000 in property at 7% would grow to just over $800,000.
  • $100,000 in bonds at 6% would grow to nearly $600,000.

Investment risk and the returns that tend to go with it, then, can be good for people investing over long periods. In fact, taking too little risk can be harmful.

Those who keep their long-term savings in bank term deposits or low-risk KiwiSaver funds will probably end up with a much smaller total than those who take on some investment risk. Sometimes they might even find that, because of inflation, the buying power of their savings decreases over time.

It’s crucial, though, to understand the risks you face in an investment. You can avoid or reduce some risks without lowering your expected return, while other risks are unavoidable if you want a higher return.

Knowing about unavoidable risks, you might decide to give the investment a miss, or to modify it. You might, though, decide to forge ahead anyway, while planning what you will do if things go wrong. Planning can make a huge difference to your ability to cope.

In investment, knowledge is power.

Footnote: When we say shares tend to be riskier than property, that’s assuming we haven’t borrowed to invest in either one. However, it’s common for people to take out a mortgage to invest in property, but not to borrow for share investment. And borrowing increases risk.

It’s quite possible, therefore, that a mortgaged property investment will come with higher risk and higher expected returns than an ordinary share investment.

Free copies of “Upside, downside — a guide to risk for savers and investors” are available from The Knowledge Centre, the Reserve Bank, PO Box 2498, Wellington, 6140, by phoning 04 471 3660 or by emailing [email protected] Or you can read the booklet or download it here. The Reserve Bank is also taking bulk orders, for members of a family, organisation, employees, clients and so on.

No paywalls or ads — just generous people like you. All Kiwis deserve accurate, unbiased financial guidance. So let’s keep it free. Can you help? Every bit makes a difference.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.