A reminder on risk
Investing involves taking some risk. There is a chance with any investment of an uncertain outcome, where the actual return is different to what was expected.
Markets have recovered from the global financial crisis, performing strongly since March 2009. After a period of strong returns, like those we have seen since 2009, our memories of what risk looks and feels like can fade. So we think it is timely to provide a brief reminder of risk – what it is, and how to manage it. We recommend you look at your portfolio to ensure you are not taking unnecessary risks. Talk to your Investment Adviser about the best approach for you.
The many faces of risk
Risk is by definition the unforeseeable. If we could predict something was going to happen it wouldn’t be unexpected and we could take action to avoid it or to reduce its impact.
Your returns will ultimately depend on the investment performance of the securities you hold. These securities are exposed directly and indirectly to a variety of risks. Investment risks that could affect your returns include:
- Market risk - changes in market conditions may affect the value of investments, for example political events, natural disasters, legislative changes and economic events;
- Specific investment risk – an individual investment may face an unforeseen adverse event, which affects the value of the underlying business and in turn, reduces the value of the investment;
- Currency risk - currency movements can have an effect on the value of any foreign investments. When a foreign investment is left unhedged, the NZ dollar value of that foreign investment will decline if the NZ dollar rises against the currency in which the foreign investment is held;
- Interest rate risk – changes in market interest rates can have a negative impact, directly or indirectly, on the value of all types of share and fixed income investments (including property based investments);
- Counterparty risk – a third party may default on their obligations resulting in a loss of value in an investment;
- Concentration risk – portfolios which have a small number of holdings or which invest in a single asset class can be affected by a single event, having impact on one security or asset class;
- Liquidity risk – if an investment is not widely traded (i.e. is illiquid) then an investor may not be able to sell the investment or may only be able to sell at a discounted price.
There are many more risks to be aware of. For more information on these refer to the Investment Statements for your service.
How to manage risk
One key strategy which we believe is the single most effective method of mitigating risk is diversification.
Diversification means investing in a range of investments, from a range of asset classes and in range of industries, economies and companies. Risk can come from anywhere and affect any market or investment. Having a prudently diversified portfolio helps insure a portfolio against uncertainty.
Diversify your portfolio by holding a range of fixed income securities, companies and/or funds in a portfolio, and by having a mix of lower-risk income assets (cash and fixed income) and higher-risk growth assets (property and shares) in a combination that suits your goals and risk profile.
Invest for the long-term rather than attempt to time the market. If possible, invest in regular instalments, which is a great way of reducing market timing risk.
Also regularly check your progress against your objectives and stick to your strategy. Don’t ignore risk. It may seem to be hibernating at present, but it has a habit of giving us sharp wake-up calls when we least expect it.
More information about diversification and how to manage risk is available in our book ‘Investing Between the Flags’. Talk to your Investment Adviser if you would like to discuss what you currently hold and the best approach for you.