Investing in New Zealand, like anywhere else in the world, involves risk. Understanding these risks and learning how to manage them is crucial for building and protecting your wealth. This guide provides practical advice and insights tailored for Kiwi investors.
Understanding Investment Risk
Risk, in investment terms, boils down to the possibility of losing some or all of your money. It’s the uncertainty about the returns you might expect from an investment. It’s not something to be feared, but something to be managed. Different investments carry different levels of risk, and understanding your own risk tolerance is the first step towards making informed decisions.
Types of Investment Risks in New Zealand
Several types of risks can impact your investments in New Zealand. Here are some key categories:
Market Risk: This is the risk that the overall market performance will negatively impact your investments. For example, a downturn in the New Zealand stock market (NZX) would likely affect the value of shares you own in Kiwi companies. Economic recessions, global events, and political instability can all contribute to market risk. In New Zealand, our relatively small, open economy makes us particularly susceptible to global shocks.
Inflation Risk: Inflation erodes the purchasing power of your money. If your investments don’t keep pace with inflation, your real returns (returns after accounting for inflation) will be lower than expected, meaning your money buys less in the future. For instance, if inflation is at 3% and your investment returns 2%, your real return is actually -1%. Protecting against inflation can involve investing in assets like property or inflation-indexed bonds.
Interest Rate Risk: Changes in interest rates can impact the value of fixed-income investments like bonds. When interest rates rise, the value of existing bonds typically falls, as new bonds offer a higher yield. Conversely, falling interest rates can increase bond values. The Reserve Bank of New Zealand (RBNZ) sets the Official Cash Rate (OCR) , influencing interest rates across the country.
Credit Risk: This is the risk that a borrower (like a company or government) will default on their debt obligations. If you invest in corporate bonds, there’s always a chance that the company could go bankrupt and be unable to repay you. Credit ratings, provided by agencies like Standard & Poor’s and Moody’s, can help assess the creditworthiness of borrowers. While New Zealand generally has high credit ratings compared to many other countries, investing in lower-rated bonds (often called “junk bonds”) carries higher credit risk.
Liquidity Risk: This is the risk that you won’t be able to sell an investment quickly enough to prevent a loss. Some assets, like certain types of property or shares in small, unlisted companies, can be difficult to sell quickly, especially in a down market. This can be a significant problem if you need access to your money urgently. Investing in more liquid assets, such as shares in large, actively traded companies listed on the NZX, can help mitigate this risk.
Currency Risk: If you invest in overseas assets (e.g., international shares or bonds), you’re exposed to currency risk. Changes in the exchange rate between the New Zealand dollar (NZD) and other currencies can impact your returns. For example, if you invest in US shares and the NZD strengthens against the USD, your returns in NZD terms will be lower (and vice-versa). Hedging currency risk is possible but adds complexity and cost.
Company-Specific Risk: This relates to risks specific to an individual company, such as poor management decisions, product failures, or legal issues. Diversifying your portfolio across multiple companies can reduce the impact of company-specific risk.
Concentration Risk: This occurs when you have too much of your investment portfolio allocated to a single asset or asset class. For example, if a significant portion of your investments is in a single property, you’re heavily exposed to the risks associated with the property market in that specific location. Diversification helps reduce concentration risk.
Assessing Your Risk Tolerance
Before making any investment decisions, it’s essential to understand your own risk tolerance. This is your ability and willingness to accept potential losses in exchange for the possibility of higher returns. Factors that influence your risk tolerance include:
Age and Time Horizon: Younger investors with a longer time horizon (the time until they need to access their investments) generally have a higher risk tolerance, as they have more time to recover from potential losses. Older investors closer to retirement typically have a lower risk tolerance, as they need to preserve their capital.
Financial Situation: Your income, savings, and other assets all play a role. If you have a strong financial foundation, you may be more comfortable taking on higher risk investments.
Financial Goals: What are you investing for? Retirement, a house deposit, education? The time horizon and importance of your goals will influence your risk tolerance. Long-term goals, like retirement, may allow for higher-risk investments than short-term goals, like a house deposit.
Knowledge and Experience: The more you understand about investing, the more comfortable you may be taking on risk. Lack of knowledge often leads to increased anxiety and aversion to risk.
Emotional Factors: Some people are simply more comfortable with uncertainty than others. Your personality and how you react to market fluctuations will influence your risk tolerance. Are you likely to panic sell when the market drops, or can you stay calm and ride out the volatility?
There are many online risk tolerance questionnaires available that can help you assess your own risk profile. However, these should be used as a starting point, not as a definitive answer. Consider discussing your risk tolerance with a qualified financial advisor.
Strategies for Managing Investment Risk in New Zealand
Once you understand your risk tolerance, you can implement strategies to manage investment risk effectively. Here are some key strategies tailored for Kiwi investors:
Diversification: This is the most fundamental risk management strategy. Diversifying your portfolio means spreading your investments across different asset classes (e.g., shares, bonds, property), sectors (e.g., technology, healthcare, consumer staples), and geographic regions. Diversification reduces the impact of any single investment performing poorly. In New Zealand, this might involve investing in a mix of NZX-listed companies, international shares (through index funds or ETFs), New Zealand government bonds, and perhaps even residential or commercial property. KiwiSaver funds are often diversified automatically, offering broad exposure to different asset classes. InvestNow and Sharesies are popular platforms those in New Zealand use to help diversify their holdings.
Asset Allocation: This refers to the process of deciding how toallocate your investments among different asset classes. Your asset allocation should be based on your risk tolerance, time horizon, and financial goals. A common rule of thumb is that younger investors with a longer time horizon can allocate a larger portion of their portfolio to shares (which typically offer higher returns but also carry higher risk), while older investors closer to retirement should allocate a larger portion to bonds (which are generally less risky but offer lower returns).
Dollar-Cost Averaging: This involves investing a fixed amount of money at regular intervals, regardless of market conditions. This helps to smooth out the impact of market volatility, as you’ll be buying more shares when prices are low and fewer shares when prices are high. Dollar-cost averaging is particularly useful for long-term investors who are contributing regularly to their KiwiSaver or other investment accounts.
Rebalancing: Over time, your asset allocation may drift away from your target allocation due to differences in performance among different asset classes. Rebalancing involves selling some assets that have performed well and buying assets that have performed poorly to bring your portfolio back into alignment with your target allocation. Rebalancing helps to maintain your desired risk level and can also improve returns over the long term.
Hedging: Hedging involves using financial instruments to reduce your exposure to specific risks, such as currency risk or interest rate risk. Hedging can be complex and expensive, and is generally more suitable for sophisticated investors who understand the risks involved. For example, a New Zealand company that exports goods to the US might use currency forwards to hedge against the risk of the NZD strengthening against the USD.
Stop-Loss Orders: A stop-loss order is an instruction to your broker to sell an investment if its price falls below a certain level. This can help to limit your losses if an investment performs poorly. However, stop-loss orders can also be triggered by temporary market fluctuations, so it’s important to set them at an appropriate level.
Due Diligence: Before investing in any company or asset, do your research. Understand the business, its financial performance, and the risks involved. Read company reports, analyst opinions, and news articles. Don’t rely solely on the advice of others. The Financial Markets Authority (FMA) provides guidance and resources for investors in New Zealand.
Seek Professional Advice: If you’re unsure about how to manage investment risk, consider seeking advice from a qualified financial advisor. A good advisor can help you assess your risk tolerance, develop a suitable investment strategy, and monitor your portfolio over time. In New Zealand, financial advisors must be licensed by the FMA. Be sure to check the advisor’s credentials and reviews before making any decisions.
Specific Investment Options in New Zealand and their Risks
Understanding the specific risks associated with different investment options in New Zealand is crucial for informed decision-making. Here’s a breakdown:
Shares (Equities): Shares represent ownership in a company. They offer the potential for high returns but also carry significant risk. Share prices can fluctuate wildly based on company performance, market sentiment, and economic conditions. Investing in individual shares requires significant research. Index funds or Exchange Traded Funds (ETFs) tracking the NZX 50 or global indexes offer a diversified way to invest in shares. Common platforms include ASB Securities, Jarden Direct, and Sharesies.
Risk: High (Market risk, company-specific risk, liquidity risk)
Example: Investing in Air New Zealand shares. The company’s performance is susceptible to economic downturns, fuel prices, and global events.
Bonds (Fixed Income): Bonds are debt securities issued by governments or corporations. They generally offer lower returns than shares but are also less risky. Bond prices are sensitive to changes in interest rates. New Zealand government bonds are considered very safe, while corporate bonds carry higher credit risk.
Risk: Low to Medium (Interest rate risk, credit risk, inflation risk)
Example: Investing in a Kiwibank bond. There is a risk Kiwibank will not be able to repay the bond if it goes into financial distress.
Property: Property can be a good long-term investment, but it’s also illiquid and carries significant risks. Property values can fluctuate based on economic conditions, interest rates, and local market dynamics. Owning rental property also involves management responsibilities and potential vacancy periods.
Risk: Medium to High (Liquidity risk, interest rate risk, concentration risk, tenant risk)
Example: Investing in a rental property in Auckland. Vacancy rates, interest rate rises on mortgages, and property market downturns can all negatively impact the investment.
KiwiSaver: KiwiSaver is a retirement savings scheme that offers tax advantages and employer contributions. KiwiSaver funds invest in a range of assets, typically including shares, bonds, and property. The level of risk depends on the specific fund you choose. Growth funds typically have a higher allocation to shares and carry higher risk, while conservative funds have a higher allocation to bonds and carry lower risk. Sorted.org.nz offers fantastic KiwiSaver comparisons and tools to help choose a provider.
Risk: Varies depending on fund type (Growth funds: Medium to High, Conservative funds: Low to Medium)
Example: Investing in a growth KiwiSaver fund. While typically offering higher long-term returns, your account balance can experience significant fluctuations, especially during an economic downturn.
Managed Funds: Managed funds pool money from multiple investors to invest in a portfolio of assets. They offer diversification and professional management but also come with fees. The risk level depends on the fund’s investment strategy.
Risk: Varies depending on fund type (Can range from low to high)
Example: Investing in a balanced managed fund. While offering diversification, the fund’s performance is still subject to market fluctuations and the skill of the fund manager.
Term Deposits: Term deposits are a low-risk investment where you deposit a sum of money with a bank for a fixed period of time at a fixed interest rate. They offer guaranteed returns but typically have lower returns than other investments.
Risk: Very Low (Inflation risk)
Example: Locking in a term deposit with your bank. The interest is guaranteed, however your rate of investment may not keep up with the inflation taking place, eroding the value of the funds.
Case Studies: Kiwi Investment Scenarios and Risk Management
Let’s look at some real-life scenarios of New Zealand investors and how they might manage risk:
Scenario 1: Young Professional Investing for Retirement. Sarah, 25, has recently started her career and wants to invest for retirement. She has a long time horizon and a high-risk tolerance.
Risk Management Strategy: Sarah should allocate a large portion of her investments to shares, either through a growth KiwiSaver fund or by investing in diversified share ETFs. She should use dollar-cost averaging to invest regularly and rebalance her portfolio periodically.
Scenario 2: Family Saving for a House Deposit. The Williams family wants to save for a house deposit within the next 3-5 years. They have a medium-risk tolerance.
Risk Management Strategy: The Williams family should allocate a smaller portion of their savings to shares and a larger portion to more conservative investments like bonds or term deposits. They should avoid high-risk investments and focus on preserving capital. A high-interest savings account could also be beneficial.
Scenario 3: Retiree Seeking Income. John, 65, has retired and needs to generate income from his investments. He has a low-risk tolerance.
Risk Management Strategy: John should allocate a large portion of his investments to bonds and dividend-paying shares. He can also consider investing in rental property, but should be aware of the risks involved. He should prioritize capital preservation over maximizing returns.
Common Mistakes Kiwi Investors Make
Even with the best intentions, Kiwi investors can sometimes make mistakes that increase their investment risk. Here are some common pitfalls to avoid:
Chasing High Returns: Don’t be tempted by investments that promise unusually high returns. These investments are often scams or carry extremely high risk.
Failing to Diversify: Putting all your eggs in one basket is a recipe for disaster. Diversify your portfolio across different asset classes, sectors, and geographic regions.
Investing Based on Emotion: Don’t let fear or greed drive your investment decisions. Stick to your investment strategy and avoid making impulsive changes based on market fluctuations.
Ignoring Fees: Fees can eat into your returns over time. Be aware of the fees associated with your investments and choose low-cost options where possible.
Procrastinating: Delaying investing can cost you valuable time and potential returns. Start investing as early as possible, even if it’s just a small amount.
Not Reviewing Your Portfolio Regularly: Markets change, and your personal circumstances may change as well. Review your portfolio at least annually and make adjustments as needed.
Regulations and Protections for Investors in New Zealand
The New Zealand financial market is regulated by the Financial Markets Authority (FMA). The FMA is responsible for promoting fair, efficient, and transparent financial markets. It also has the power to investigate and prosecute breaches of financial market laws. The FMA also runs Investor Education programs. The Financial Dispute Resolution Service (FDRS) provides a free and independent service for resolving disputes between consumers and financial service providers. These protections are in place to help ensure that investors are treated fairly and that their interests are protected.
FAQ Section
Here are some frequently asked questions about investment risk:
What is the difference between risk and volatility?
Risk is the possibility of losing money on an investment. Volatility is the degree to which an investment’s price fluctuates over time. High volatility doesn’t necessarily mean high risk, but it can increase the potential for both gains and losses.
How do I know if an investment is too risky for me?
Consider your risk tolerance, time horizon, and financial goals. If you feel uncomfortable with the potential losses associated with an investment, it’s probably too risky for you.
What should I do if my investments are losing money?
Don’t panic! Market fluctuations are normal. Review your investment strategy and consider whether it’s still appropriate for your risk tolerance and financial goals. If you’re unsure, seek advice from a qualified financial advisor.
Is it possible to eliminate investment risk altogether?
No. There is no such thing as a risk-free investment. However, you can manage investment risk by diversifying your portfolio, allocating your assets appropriately, and investing for the long term.
What is a “bear market” and how does it affect my investments?
A bear market is a period of sustained decline in stock prices, typically defined as a decline of 20% or more from a recent peak. Bear markets can be unsettling, but they also present opportunities to buy stocks at lower prices. It is crucial to review your portfolio and adjust accordingly.
References
Reserve Bank of New Zealand – www.rbnz.govt.nz
Financial Markets Authority (FMA) – www.fma.govt.nz
Sorted.org.nz – www.sorted.org.nz
Investing in New Zealand requires a solid grasp of risk management principles. By understanding the different types of risks, assessing your own risk tolerance, and implementing appropriate risk management strategies, you can better protect your wealth and achieve your financial goals. Don’t wait – start taking control of your investment risk today. Consider speaking with a financial advisor to develop a personalized strategy that aligns with your unique circumstances and objectives.
