The Question of Risk & Reward.
When faced with the question ’What sort of a return would you like to make on your Superannuation Investments?’ some people say they would love to make a lot of money but they don’t want to lose any.
Unfortunately there is a very strong relationship between ‘Risk and Reward’. It is pretty straight forward, the more money you want to make from an investment the more risk you are going to have to take to get there. However that is not the end of it, the more potential you have to make money from an investment the more potential you have to lose money as well.
I have been aware over the years that a lot of people don’t know the relationship between Risk and Reward but I was really shocked when I read a study from the Australian Securities Investment Commission (ASIC) that showed only 9% of people knew that if you want a higher return you need to take on more risk.
So let’s take a look at the risk/reward on the major asset classes.
The main asset classes for building your Superannuation wealth are Cash, Fixed Interest Property and Shares.
Cash investments typically comprise on-call and term deposits with banks and other financial institutions. The great thing about cash is it has the lowest level of risk, unfortunately though it has the lowest return.
Fixed Interest products include but are not limited to government and corporate bonds. The feature with these investments is that they provide a steady income stream throughout the period of the investment. Returns are usually slightly higher than cash investments, which compensates investors for the fact that fixed interest products are less liquid and are generally for a fixed term.
Each type of property comes with a different risk/reward matrix. Buying an empty office block on the Gold Coast comes with a much higher risk reward than that of a fully leased office in Sydney. Likewise a residential property in a mining town would also have a much higher risk reward than a three bedroom house in the suburbs in Melbourne.
Property as a whole has a higher level of return and as a result a higher level of risk than cash and fixed interest as it is subject to greater volatility and you are subject to capital losses.
The advantages attached to investing in shares is the higher potential for capital growth over the medium to long term and the entitlement to Franking Credits. On the downside there is the potential for capital loss as the market value of shares can be volatile.
All stocks carry different risk rewards. Our top 50 Stocks are classified as Blue Chips and are generally safer and less volatile than that of small and mid cap stocks. If you buy a small cap tech start up stock you may have the potential to triple your money in a short period of time but you also stand to lose significant amounts if the technology is not a success. Whilst if you buy Telstra it is not going to triple overnight and it is also unlikely to crash overnight due to its solid revenue streams and strong dividends.
In addition purchasing International shares comes with the risk that the currency moves against you at the time you want to sell the shares and bring your money back to Australia.
Asset Class 20 Year returns up to December 2015
Source: Russell Investment – Returns are after costs and tax in Accumulation Phase within Superannuation.
The overall message is this: Know what you are invested in and understand the Risk/Reward of your entire Portfolio. Life becomes much easier and less stressful when you understand the relationship between Risk and Reward.