1. Investors
  2. Deciding how to invest
  3. Understanding risk

Understanding risk

Risk isn’t bad; it’s a normal part of investing. It’s the chance you take that you won’t get the return you expected on your investment, or that you might lose some or all of the money you invested.

Risk can also improve your chances of getting a good return. Having a clear understanding of your own goals and attitude to risk will help you work out how much risk to take.

7 general investment risks

  1. Interest rate risk: when interest rates rise after you lock in your money, meaning you don't earn as much on your money as you would have if you'd invested at the higher rate.
  2. Liquidity risk: there might not be buyers interested in your investment when you want to sell.
  3. Credit risk: the organisation may not be able to repay its debts, and you might lose your money.
  4. Economic risk: the economy may or may not be doing well, which could affect the value of your investment.
  5. Industry risk: risks affecting a particular industry, like shortages of raw materials or changes in consumer preferences.
  6. Currency risk: your investment is affected by changes in the value of the New Zealand dollar.
  7. Inflation risk: your investment doesn't earn enough to keep up with inflation.

Why risk isn’t bad

Taking on risk is what you’re getting paid for, through investment returns. If you take on more risk you should get paid more in return. That’s the only reason to take on more risk.

Risk is only bad if:

  • you’ve accepted too much or too little for your investment goal; and/or
  • you’re not being paid enough in return to compensate you for the risk you’ve accepted. 

How risk affects your investment

Lower risk investments have fewer ups and downs over time. But if you invest in lower risk products it’s possible your money won’t grow as fast as inflation. This means your money could be worth less when you eventually spend it.

Higher risk investments have a lot more ups and downs. You’d expect your returns to drop much more frequently, and in larger amounts. It’s hard to predict how they’ll perform, but if you’re investing for at least 10 years you should end up with a larger amount than if you’d taken less risk.

How to check the likely risk of an investment

1. Check the risk indicator

If you’re investing in managed fund (like KiwiSaver), the risk indicator helps you understand how likely it is that the fund’s value will go up and down (volatility). You can use the risk indicator to help assess risk and compare funds.

risk indicator

You should also check how the fund is invested. If it invests in a high proportion of shares and property, the risk indicator will get higher when markets are more volatile.

2. Check the credit rating

If you’re investing in fixed interest investments, like bonds, credit ratings help you understand how likely it is you’ll get your money back at maturity, and that interest will be paid on time.

Ratings are issued by independent agencies such as Standard & Poor’s, Moody’s and Fitch. These agencies have different credit rating systems, and they’re only one factor you need to take into account.

See credit ratings.

3. Read the risk section of the product disclosure statement (PDS)

Most investments have to provide a PDS. This explains the general risks of investing as well as the specific risks of the particular product.

4. Read all other material available to you before you invest.

Find out how the investment is structured – this can make it riskier. For example, capital notes are bonds that can convert into shares so they're riskier than normal bonds. If you don’t understand how a product works, don’t invest before speaking to a financial adviser.

5. Check the investment isn’t a scam

See avoid scams for details of how to check your investment is legitimate.

6. Don't put all your eggs in one basket

Each investment has different risks, so some investments go up when others might go down. Investments can also fail, regardless of your research.

You can protect yourself against this by having more than one investment, and more than one type of investment. This is called diversification – not putting all of your eggs in one basket.

Managed fund providers (such as KiwiSaver scheme providers) offer diversified funds, which are invested in a mix of cash, shares and property.