4 common myths about investment risk

26 July 2024

When exploring your investment choices, it’s important to understand risk and your personal appetite for it. Many people associate risk with the chance of losing money – making it something they avoid at all costs. In reality, not taking risks can lead to lost opportunities when it comes to returns on investment.

Here are 4 of the most common myths and misconceptions about investment risk:

Myth 1: Shares are too risky

The nature of risk changes depending on how long you can invest. In the short-term (up to 5 years) the biggest risk comes from market volatility – uncertain market conditions. For example, if you need your money in this time frame and a downturn occurs your investments may not have enough time to recover.

This is the type of risk that many investors dwell on. However, avoiding this type of risk often comes at a cost: lower returns.

Example
AustralianSuper's Cash investment option is a very low-risk choice, meaning that the potential of a negative return is low for the option. However, the lower risk profile of the Cash option has also provided a lower level of returns. Over the 10 years to 30 June 2024, its average annual return was just 1.84%.  

On the other hand, the Australian Shares investment option is exposed to a higher level of market volatility. It’s estimated that the option could deliver an annual negative return about 6 times over any 20-year period. Over the same 10-year period to 30 June 2024, the Australian Shares investment option delivered an average return of 9.24% a year¹. So, taking on this level of risk may have the potential for higher returns in your portfolio.

Myth 2: Cash is a low risk choice

Cash is a relatively low-risk investment that provides portfolio stability, but that comes at the expense of lower returns. Saving for retirement typically involves investing for the long-term, and that means investing through economic cycles that can impact returns. These cycles may increase or decrease your super balance in the short-term. However, portfolios that include more growth assets tend to perform better over time.

If you plan to invest for more than 20 years, focusing on the long-term allows you to invest in assets that offer the chance of higher returns.

Moving to cash to avoid short-term market volatility can negatively impact portfolio return when the markets rise after a downturn. History shows us that markets have rebounded from downturns, making short-term market volatility a minor disruption to long-term performance.

Growth assets, like shares, can increase in value quickly after a downturn – so missing out on the upswing in performance can have a negative effect on your long-term returns.

Importantly, the low returns of cash over the long term can also make it difficult for your investment return to keep pace with inflation. If the price of goods and services rise at a higher rate than the return on your cash, you won’t be able to buy as much in the future.

Myth 3: We need to avoid investment risk as we get older

Another risk you face over the long–term is longevity risk – the chance that you'll run out of money because you live longer than expected. While the Government Age Pension provides an important safety net, many retirees aim for a more comfortable lifestyle than the pension alone can provide.

Funding that lifestyle and making your retirement savings last longer requires investing in higher-returning growth assets, but many people gravitate to less volatile investments as they grow older. That’s due to loss aversion, a common behavioural bias that makes the expected pain of a loss outweigh the benefits that higher returns would provide.

According to government data, the average retiree aged 65 is likely to live for around another 2 decades². This means it can pay to continue investing an appropriate amount in growth assets to support your income needs.

Myth 4: Volatility is the only risk

The nature of risk changes when you’re investing over a longer period of time. While volatility is still something to be mindful of over the medium term (5–20 years) and the long term (20 years plus), the impact of inflation is also a risk to consider.

Inflation risk refers to the impact of price rises over time on the purchasing power of your money. If your savings or wages don't rise to match or outpace those price increases, your quality of living could decrease. This can have a big impact in the long run.

While market volatility is an obvious risk, the impact of inflation is less visible. The face value of $100 in your pocket stays the same but, in reality, it’s worth less over time as prices rise. Consider that a $5.30 takeaway coffee today could cost $11.10 in 30 years if inflation rises by 2.5% per year.

This is why it's crucial to take on the right level of investment risk. Some risk may generate higher returns and offset the gradual erosion in wealth resulting from inflation.

LEARN MORE: POTENTIAL BENEFITS OF INVESTING IN RETIREMENT

AustralianSuper's Balanced investment option aims to outpace inflation as measured by the Consumer Price Index (CPI) by more than 4% a year over the medium to longer term. It does this by investing in a wide array of diversified assets, which are actively managed to generate growth over the medium to long term.

Managing your risk strategy

Risk is a normal part of investing. To work out the right level of risk for you, it’s important to consider factors such as:

• how much you’ve saved
• how much money you’re planning to withdraw; and
• your investment objectives and timeframe. 

Get advice about investment and risk
For personal advice on your investment options, super and retirement planning - at any stage of your life - consider speaking to a financial adviser.