What is risk aversion?
In finance and superannuation, the meaning of risk aversion relates to a person’s approach to investing. People who choose more stable investments, even if that means getting lower returns, are said to be risk averse. This is certainly not a negative though, and for some people, being risk averse can be a smart move.
If you are risk averse, you are likely to prefer investment portfolios that are regarded as conservative or defensive.
When is it good to be risk averse?
A short investment timeframe is usually a key reason to be risk averse.
While the value of any investment can go up or down, generally speaking, the longer your money can be invested, the more likely it will be able to cope with fluctuations in value. This means that if you are nearing retirement and want to start drawing down on your super soon, you may be more inclined to towards a lower-risk investment style.
Super funds are required to disclose the level of risk for each of their investment options using the Standard Risk Measure (SRM). The SRM describes the level of risk for each investment option as the estimated number of negative annual returns, over any 20-year period. A low-risk investment is usually one that can expect a negative return only about once in any 20-year period, whereas a high-risk portfolio can see as many as four to less than six negative years in the same period.
How does this relate to superannuation?
If you are a member of an Industry SuperFund, and you feel it is worth being risk averse, then you can choose a more conservative or defensive investment package
What are low-risk investments?
Traditionally, cash, term deposits, fixed interest accounts and government bonds are regarded as low-risk assets. They tend to be stable and reliable, but grow slowly and provide lower returns through interest. Low-risk or conservative investment options tend to include higher levels of these reliable investments in their mix.
Higher-risk investments are assets such as shares and derivatives, because, although they have the potential to deliver higher returns, they are also more volatile.
That said, even within shares there are different levels of risk, for example, shares in a large, well-established blue-chip company can be regarded as quite safe, though returns may be lower. So blue-chip shares and investments in property trusts may be included in conservative, lower-risk portfolios.
What’s the opposite of risk averse?
Risk tolerance is often seen as the opposite of risk aversion. As it implies, you – or more importantly, your financial situation – can tolerate risk, even though you don’t necessarily go seeking it.
Investors who are risk tolerant take the view that long-term gains will outweigh any short-term losses.
Better returns for the risk averse
Investment losses are not the only things that can eat into your superannuation. Account management fees and hidden costs can also be devastating.
Fortunately, Industry SuperFunds charge low fees, so that even in negative return years, losses are kept to a minimum.
What’s more Industry SuperFunds have, on average, outperformed retail funds for the past 15 years at a lower cost. Compare for yourself here.