Choosing Wisely - Understanding risk

When considering different investing options it can be hard to know which offer is the right one for you. The right investment depends on your unique circumstances. Your financial position, investment timeframe, financial goals and appetite for risk are all important factors.

When considering investing in managed funds, a useful way to compare investment options is by referring to the risk indicator. The risk indicator measures the volatility of a fund’s returns. Because all retail managed funds in New Zealand are required to calculate and publish their risk indicator category, the risk indicator provides a simple to understand, consistent comparison of each fund’s volatility profile—including both the potential for loss and for growth. You can find a retail fund’s risk indicator category in its product disclosure statement.

The risk indicator uses a simple scale from 1 (indicating lower risk and potentially lower returns) to 7 (indicating higher risk and potentially higher returns), based on the historical volatility of a fund’s returns. A higher rating suggests greater potential for long-term returns — but also more frequent or larger ups and downs along the way. In contrast, a lower rating indicates more stability but typically lower potential returns.

It’s important to note that even the lowest category of “1” does not indicate a risk-free investment, and there are other important risks that are not captured in this rating.

For example, the risk indicator does not measure a fund’s liquidity risk (the risk that a fund will not have sufficient liquid assets to meet withdrawal requests), inflation risk (which recognises that inflation reduces the real value of all investments), operational risk (the risk that a fund’s manager may be impacted by operational or system failures), and key person risks (the risk that the departure of key personnel could adversely affect the fund manager’s business processes or investment assessments).

These are all particular risks for the Midlands Smarter PIE Fund – and more information to explain these risks and what we do to manage them is included in our Product Disclosure Statement.

Other managed funds have their own specific risks, which you can understand by reading the fund’s product disclosure statement.

Risk indicators are not calculated for bank term deposits. However, they are generally accepted as being very low risk – lower risk than the Midlands Smarter PIE Fund and other managed funds with a risk indicator category of 1.

Bank term deposits also benefit from coverage by the Depositor Compensation Scheme. The DCS covers deposits of up to $100,000 per eligible person, per institution, should a financial institution covered by the DCS fail. Investments in the Midlands Smarter PIE Fund are not covered by the DCS.

However, the low risk associated with bank term deposits means they typically offer lower returns than other common types of investments and may struggle to keep up with inflation in a low-rate or highly inflationary environment.

As an investor, it is important to understand your appetite for risk and your tolerance of volatility. To help you clarify your own attitude to risk, you can seek financial advice or work out your risk profile at www.sorted.org.nz/tools/investor-kickstarter.

Once you understand your views on risk, the risk indicator and minimum investment timeframes are both good tools to help you compare funds, and each fund’s product disclosure statement will explain the specific risks that apply to that fund which aren’t reflected in its risk indicator. If you are unsure, you should speak to a financial adviser,