“The global financial crisis has focused investor attention on one kind of risk, market risk – the risk associated with market volatility – and whether we are still in a bear market.

“As a result, investors have made avoiding or minimising this risk their priority, resulting in them keeping most, if not all, their money in cash, rather than focusing on their ultimate goal which is a retirement income that will last.

“Even now, when volatility has largely returned to pre-GFC levels, many investors are still keeping a significant proportion of their retirement savings in cash options such as term deposits, in the belief that this is the least-risky strategy.

“However, while this approach minimises market risk, it exposes investors to a number of other risks including inflation risk, income risk and opportunity risk,” Mr Dickman says.

He said that inflation risk, which is when higher levels of inflation eat away at returns and capital, is a major issue for those who have money in term deposits.

“As the interest rates offered on term deposits fall – as they are already starting to do – the return on the capital will also decrease.

“Inflation also means that capital locked up in a non-growth asset will have less value at the end of its two, three or five year term.

“Opportunity risk is associated with this. If the money is locked away in a term deposit for two, three or five years, it is money that can’t be used elsewhere – therefore opportunities for better returns and capital growth are being missed,” he said.

Mr Dickman added that perhaps the biggest risk for investors at the moment is income risk.

“Investors who took their money out of other investments to put into cash when the government introduced the bank guarantee have most likely sacrificed income.

“Term deposits may seem a safe haven now, but people probably don’t realise that this choice means they have introduced future income risk into their portfolio.

“With the first of the baby-boomer generation now entering retirement, as well as the trend of longer life expectancy, a stable, regular income will become a priority. This is something people won’t get from a term deposit where the interest is usually paid at the end of the term.

“Indeed, the burgeoning ageing population, combined with the higher health costs associated with people living longer, makes it even more important for Australians to be adequately prepared to fund their retirement.  A potential risk in its own right is relying on future governments to pick up the tab for those who run out of money.

“Therefore retirees in particular need to consider other investments, and find a balance between their desire for low-risk investments and their need for returns that will generate ongoing income in their retirement.

“It comes back to the value of taking a balanced approach through a diversified portfolio, and understanding that different investments offer different benefits, returns and risks.

“No single investment will provide investors with all three elements of high liquidity, high returns and low risk, so a combination is needed.

“Diversity also helps to manage all types of risk.

“Investors must assess each individual asset class on its own merits and make investment choices based on their own needs of income, liquidity, growth and risk,” Mr Dickman said.

The post More to risk than market volatility appeared first on AdviserVoice.

 ‘By investing in a sector ETF, as opposed to an individual security, investors are minimising stock specific risk, yet still receiving all the benefits of investing directly in the underlying securities. Benefits such as any capital appreciation, dividends and any associated franking credits coming directly to them and not being diluted in a managed fund,” said Annmaree Varelas, CEO, Australian Index Investments. 

 Australian Index Investments (Aii), an independent Australian Investment Manager, listed a series of six sector ETFs in early 2010 tracking the following market indices:

•  Aii S&P/ASX 200 Financials (ASX code: FIN)
• Aii S&P/ASX 200 Financials x-A-REITs (FIX)
• Aii S&P/ASX 200 Resources (RSR)
• Aii S&P/ASX 300 Metals & Mining (MAM)
• Aii S&P/ASX 200 Energy (ENY)
• Aii S&P/ASX 200 Industrials (IDD)

 SMSFs

More sophisticated or aspiring investors are starting SMSFs and a lot of ETF growth is coming from SMSF trustees.

 The ATO estimates that around 60% of SMSF assets are invested in direct Australian shares and liquid assets (cash and term deposits). The ATO also estimated that 20% of assets are invested in “managed investments”, 6% of which are listed managed investments including ETFs.

 “Based on similar experiences overseas, Australia is on the cusp of a massive growth curve for ETFs, with the market set to climb from $3b FUM to $25b over the next 7-8 years. Some of the reasons for this include investor desire for low cost, transparent and liquid investment products (thanks to the GFC).

 “Also, there is a clear move away from commissions to fee-for-service and the fact that ETFs are one of the few ways that an SMSF trustee can gear Australian equities within their fund,” said Ms Varelas.

 Costs

ETFs trade like a share, so brokerage will be incurred when a parcel of ETFs is bought and sold. Other than that, the only other cost is an annualised MER of 0.43% for each fund.

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