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May 07 newsletter

Investment risk

All investments contain risk. Even New Zealand Government bonds may not be able to be repaid following a major financial and national catastrophic event. But investments have different levels of risk. And it is those different levels of risk that determine, in part, the level of your investment return. This newsletter sets out some of those risks.

Loss of capital - problem

The loss of investment capital is the risk of most concern. Will we lose all our money if we invest in finance company A, or if we invest in share B on the stock exchange? These are reasonable fears, with several finance companies in financial strife last year and the 20 year anniversary of the 1987 sharemarket crash in the media this year.

Loss of capital - solution

The best way you can protect yourself is to diversify your investments. Diversify by investment class (if possible, invest in shares, fixed interest and property investments), by company (invest in a bunch of companies, not just one finance company and not just one share) and have some overseas investments.

Volatility of returns – problem

“Volatility of returns” simply refers to the changes in the value of your investments, from month to month or year to year. In other words, it is the huge swing between gains and losses generally experienced by shares and currency movements.

The risk here is that the volatility of returns may cause investors to become worried about the reduced value of investments, or lack of performance, unnecessarily selling when the value of their investments is only temporarily low.

Volatility of returns – solution

Again, the best way to protect yourself is to diversify your investments. However, you should also understand your risk profile and ensure that your investment portfolio fits comfortably within that risk profile. A risk-adverse investor with a high percentage of investments in shares will feel the anguish of investment volatility.

Capacity of risk – problem

You don’t want some unforeseen event, such as an illness, to also cause investment pain. If you are suddenly short of cash, for any reason, you don’t want to be in a position where, again, you may unnecessarily have to sell long-term investments when their value is temporarily low.

Capacity of risk – solution

Liquidity is the key. Have some form of emergency funding available at all times, and ensure that you carry full life and disability insurances where necessary.

Random page of the month

Retirement planning has been in the media recently.