Following on from Part I, let’s look at some of the other major risks when planning for retirement.
Business risk
- What it is - This refers to the risk associated with a particular investment (e.g. a company being made bankrupt, or an investment fund investment fund going into liquidation and paying out investors at ‘cents in the dollar’).
- What people say – ‘I invested in this mining company and it went to zero’
- Example – HIH Insurance, OneTel
This risk is often confused with ‘market risk’, even though they are completely different. Business risk refers to one particular investment, while market risk refers to the price of the overall asset class falling. Sequencing risk
- What it is – A subset of market risk, sequencing risk is the risk that the order and timing of your investment returns is unfavourable.
- What people say – ‘I had $1,000,000 invested in super and it dropped to $700,00 in the GFC. It’s recovered now but I had to keep working for a few years longer than I thought’.
- Example – Two people can make identical super contributions and experience the same average returns over their working life, and still have significantly different balances to retire on, depending the ‘sequence’ of the returns.
So what’s the best way to minimise the effects of both risks? Diversification (i.e. making sure that you don’t have all your eggs in one basket). By investing across a range of different companies and sectors you can reduce the effect of any individual company going bankrupt and wiping out your retirement savings. By investing in a range of different asset classes (e.g. shares, property, cash) you can minimise the effect of a down market in any one area.Written by Dallas Davison.