Building wealth is all about risk

Building and keeping wealth seem like simple goals, which many of us strive for in our lives. But they can contradict each other. While we’d all like to avoid losing money under any circumstances, unfortunately it’s often the case that the risk you take to generate gains comes with the possibility of generating losses.

This means the critical question for every investor is ‘how do I maximise gains and minimise loss?’

All forms of investment involve risk: cash is likely to hold its value but can lose if inflation rises. The value of shares tend to rise over time but can drop during a market downturn. Property values tend to increase over the long term but can fall if interest rates rise.

Generally, you can expect lower rates of return from safer investments, such as cash or bonds; and for riskier investments, such as shares or property, greater potential returns.

Why wouldn’t you always choose the riskier investment option if it means greater returns? Because that risk might be too much to take on for your life stage. This is a concept worth explaining.

People tend to accept more risk earlier in their working life as they have more time to overcome any losses that riskier investments could generate, just as they could benefit from any higher returns. If a young person, with decades of working and contributing to super ahead of them, experiences negative returns in their super due to investment markets being down then they have plenty of time to regain that loss. The risk taken at that early stage is unlikely to be something that worries them when they get to retirement.

For those of us who may be close to retirement or already drawing income from their super, it’s a different story. At this stage of life, you are less likely to want to take on risk, preferring to preserve what you have. That’s because when we are closer to or in retirement, we don’t have much more time to stay invested and make up any losses. This is why decreasing risk as you age is the investment structure of our lifecycle MySuper option.)

But age and time isn’t the only way to manage investment risk. Diversifying investments is a central strategy that investors use. With this approach, while one investment sector (such as bonds) may decline in value, another (such as shares) may hold or increase in value – that diversification helps to manage the risk of any decline.

A third important principle is to invest in what you understand and find trusted money managers and advisers to assist you. You might be hearing about cryptocurrencies or different investment fund opportunities, especially on the internet, but unfortunately there are a lot of scams in this area. That’s why it’s so important to stick to what you understand and to find trusted sources. Our smartCoaches are always here for guidance too!

Finally, before you begin any investment, really consider how much you can afford to lose. Because with even the safest investment, there’s always a chance of the unexpected happening, leading to loss. Part of that consideration is to know what your financial goals are. And to ask yourself what would a financial loss mean to you at your life stage? And what investment returns do you need to achieve in what time frame?

The last principle is defensive investing. As mentioned above this is investing in lower risk assets. The purpose of this approach is to preserve wealth while still achieving some gains. But, even taking a defensive approach, investment markets can’t be predicted. Past performance really isn’t a guarantee of its future performance.