Understanding the basics of Investing

Assets such as equities (i.e. stocks or shares) and certain types of property are generally considered high-risk investments, as their values tend to move up and down more than other asset classes over the short term. However, they’re also expected to produce higher returns over the long term.

If you have a longer period to invest your super, higher-risk asset classes are generally considered to be more suitable. This is because your investments have more time to weather the ups and downs of the markets. These types of investments can also provide better inflation adjusted outcomes, due to their capital growth characteristics.

These assets generate returns mainly from how they “grow” in value – this is known as capital gain. They can also earn some income, for example, dividends (for equities) and rent (for property).

Assets such as Government Bonds, term deposits and cash are considered lower-risk investments as their values tend to be more stable over the short term. However, they are also expected to produce lower returns over the long term. Although bonds and fixed interest investments can have some capital gains and losses, they tend to produce returns from the income (or interest) they earn, which generally also means they won’t keep pace with inflation.

Generally, the lower the investment risk of an asset class, the lower its potential for returns over the long term.

That said, lower risk investments may not always be the right choice. Although assets like bonds and cash may appear safer, you will be missing out on the opportunity to receive higher returns, particularly if you are investing for a long time and are more able to weather the ups and downs in the meanwhile.

What does risk mean to you? Is it the value of your super savings falling? Or could it be your savings not keeping up with the cost of living (inflation), or perhaps your money running out in retirement? Risk can be all those things.

When it comes to investing, risk and return are closely linked. Based on historical returns, the more you are prepared to see out the ups and downs of investing in growth assets – that is, the more short-term risk you are prepared to take – the higher the return you can expect in the long term.

Depending on your circumstances and attitude, you may not be able to take as much investment risk and may decide that protecting your account balance is as (or more) important than growing it. Below are some different types of risk to be aware of. How might they affect your investment choices based on your personal attitude to risk.

• The risk of a negative return in any one year;
• The risk of not having enough money to live on in retirement;
• The risk of your savings not keeping up with inflation; and
• The risk of being too cautious with your investments and missing out on returns if different choices were made.

Just as it’s not ideal to have all your eggs in one basket, you might want to spread your risk with your investments. So, if you choose an investment option that has a mix of asset classes, you are spreading your risk of loss. For example, if one asset class performs poorly, the loss could be offset (partly or fully) by gains from another asset class that performs well. This is known as diversification. Most of our investment options are diversified.

Volatility is the amount of ‘ups and downs’ an investment has within a period of time. History shows that economies typically move in cycles of ‘boom and bust’. Most recently, we saw this in 2007 with the global financial crisis and again with the shutdowns caused by COVID-19.

Some asset classes, particularly shares, are more volatile because they can move up and down a lot in a short period of time. Others, like cash and fixed interest, are slower to change. This means that if your super is invested in an option with a higher proportion of shares, a fall in share markets will tend to lead to a drop in your super returns.