When it comes to choosing the right KiwiSaver fund, understanding the concepts of risk tolerance and risk capacity is crucial. KiwiSaver providers offer a variety of fund options that cater to different levels of risk tolerance and capacity. Choosing the right fund involves more than just picking one with a potentially high return; it requires careful consideration of both your personal comfort with risk and your ability to handle potential financial losses.
Risk Tolerance: Personal Comfort with Market Fluctuations
Risk tolerance refers to an individual’s psychological comfort with watching their investment rise and fall as markets change. KiwiSaver funds typically range from conservative to aggressive, with conservative funds investing more in stable, lower-yield assets, and aggressive funds opting for higher-risk investments, but potentially higher returns.
If you have a high risk tolerance, you might feel comfortable with the potential volatility of an aggressive KiwiSaver fund. This aims for higher long-term returns but with a higher likelihood of short-term fluctuations. Conversely, if market swings make you anxious, you might prefer a more conservative fund that focuses on stability and lower risk, even if it means accepting lower potential returns.
Risk Capacity: Financial Ability to Endure Losses
Risk capacity pertains to your financial ability to absorb losses without compromising your overall financial stability. When evaluating risk capacity for KiwiSaver, you should consider factors such as your age, income level, investment horizon, and financial goals.
For example, younger investors (who don’t need to access funds to purchase first home) with a long time until retirement have a higher risk capacity, because they have time to recover from market downturns. Therefore, they might opt for a growth-oriented KiwiSaver fund that invests heavily in equities (stocks) and other higher-risk assets. On the other hand, those closer to retirement are likely to have a lower risk capacity. They may instead be looking to protect their accumulated savings and minimise potential losses, meaning that conservative or balanced funds may be more suitable (even if they are comfortable with market fluctuations).
The Impact on KiwiSaver Fund Choice
Selecting a KiwiSaver fund that aligns with both your risk tolerance and risk capacity is essential for a successful retirement strategy. A mismatch could be too stressful or financially detrimental. For instance, choosing a high-risk fund without the financial ability to withstand potential losses might result in undue stress during market downturns, and could negatively impact your retirement outcome.
Conversely, a more conservative fund might be appropriate for someone nearing retirement who cannot afford significant losses. However, if this choice is driven by an overly cautious risk tolerance, it might result in missed opportunities for higher returns.
Finding the Right Balance
It’s not as difficult as it sounds to make an informed choice on which KiwiSaver fund is right for you. Start by assessing your risk tolerance through self-reflection and then evaluate your risk capacity by reviewing your financial situation, including your investment timeline and goals. Many KiwiSaver providers offer tools and guidance to help match your profile with appropriate fund options.
Financial advisers can also help you understand your risk tolerance and risk capacity. They can help you navigate the range of KiwiSaver fund choices ensuring your selection aligns with your long-term financial goals.
Conclusion
Understanding the relationship between risk tolerance and risk capacity is key to making a well-informed fund choice. By aligning your personal comfort with market risk and your financial ability to endure potential losses, you can select a KiwiSaver fund that supports your retirement plans while minimising stress and financial risk. Balancing these factors helps achieve an investment strategy which is both psychologically comfortable and financially sound, paving the way for a secure and prosperous retirement.
This article does not take into account your investment needs or personal circumstances. It is not intended to be viewed as investment or financial advice. Past performance is not a reliable indicator of future performance. Milford Funds Limited is the issuer of the Milford KiwiSaver Plan. Please read the Milford KiwiSaver Plan Product Disclosure Statement at milfordasset.com. Before investing you may wish to seek financial advice. For more information and to see our Financial Advice Provider Disclosure Statement please visit milfordasset.com/getting-advice.