Assessing risk and return when looking for high returns
AS INVESTORS, we all want to earn high returns. However, big gains go hand in hand with increased risk - something that's especially important for the thousands of Australians who hold their retirement savings in a self-managed super fund (SMSF).
A recent report by AMP Capital found SMSF trustees expect their super to earn an average return of 10.9% this year. Yet only one in five SMSFs have made changes to their portfolio to achieve this result. In fact, 55% of SMSFs have switched to lower risk investments out of concerns about market volatility.
With these findings in mind, it's worth looking at the two main types of investments to see how returns are impacted by risk.
Income assets, also known as conservative investments, include cash-based investments like term deposits, which provide income on a regular basis. The drawback is that the return on cash is typically low because there's less risk of losing your money. Right now for example, you'd be lucky to earn 3% on a term deposit.
That's not to say income assets aren't worth having. What you need to consider is how much of your money you should invest in low risk/low return investments.
Growth assets on the other hand, include property, shares, both international and Australian, and units in a managed fund that invests in these assets. The appeal of growth investments is that they offer ongoing income in the form of rent, dividends and distributions (in the case of managed funds) but they also offer capital growth plus some tax breaks.
As a guide to potential returns, Australian shares have delivered gains of 17.24% over the past 12 months - far eclipsing cash investments.
The downside to growth investments is increased risk. Capital gains are by no means guaranteed and while there will be periods when markets skyrocket there will also be times when markets dip.
It's very rewarding to see the value of your growth assets climb. But you need to be able to withstand a fall in the value of your investment, which is far from fun and can be extremely stressful, especially when it comes to retirement savings.
The appropriate mix of conservative and growth assets will vary from person to person. However, for SMSFs, especially those in the accumulation stage, having a high concentration of low risk assets could see you struggle to reach your retirement goals.
The key is to find the blend of risk and return that you're comfortable with. Diversifying across a number of different asset classes is also important as it helps to protect your portfolio against strong swings in any one investment market class.
Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.