Risk is a scary word. It brings to mind stock market crashes, diving investments and life savings slipping through your hands.

Kiwis obviously have the same ideas because as a nation we take a fairly conservative approach: only around a quarter of women and a third of men describe themselves as aggressive or growth investors, according to Financial Services Council surveys. We’ve also poured $1.5 trillion into housing because it’s seen as a safe haven.

However, our aversion to risk could be costing us. In the words of Mark Zuckerburg, and any financial adviser worth their salt, “The biggest risk is to take no risk at all”.

Why we need risk

Darcy Ungaro, CEO and adviser at Ungaro & Co, one of New Zealand’s leading boutique financial advisory firms, explains that risk is an essential ingredient for all investments.

“It’s simple.The reason we get a return is risk. It’s a scary word though, so it helps to re-frame it as volatility, and we shouldn’t be scared of volatility.”

Higher risk investments are typically those with higher volatility, meaning they change in value rapidly (up or down). Lower risk investments, like defensive funds, experience slower value changes, meaning they have less volatility.

Dean Anderson, CEO of Kernel, the country’s fastest growing investment fund, says lots of Kiwis misunderstand risk.

“When people think of risk they think their KiwiSaver is going to go to zero. That’s not going to happen. A well-diversified KiwiSaver fund or index investment may go up and down in the short run, but it’ll generally trend up over time.”

In other words, riskier or more volatile investments may go up and down faster, but they will also often have more potential for long-term growth.

All about horizons

Many of us should be taking more risk with our investments. But how do we smooth out the ups and downs caused by volatility to ensure we’re not losing money? With time.

Before you invest, think about how long it will be before you need the money. If it’s seven to 10-plus years you’ve got enough time to take a risk and choose more volatile investments. If it’s five to seven years you’ll want to be more careful. If you’ve got less than three to five years you may not want to invest at all.

Short-term investments

If you’re saving up for something and you’ll need the money in the next three years you’re probably best not to bet it all on Dogecoin. Ungaro explains that a conservative approach is best when you don’t have the luxury of time.

“Investing may not be worth it if you have less than three to five years. For this time frame I advise a lot of my clients to take out a revolving credit or offset facility on their mortgage and put the money against that. This gives you a guaranteed return in the form of reduced interest.”

This return could be in the vicinity of 6 to 7 per cent based on mortgage interest rates at the time of writing. Ungaro adds that if you don’t have a mortgage you could consider other options.

“Maybe split between term deposits on a short-term basis. Have 18 months or one-year term deposits rolling over or use a high interest savings account. You could even hold a small percentage in physical cash.”

The key thing to remember during this short time frame is that you don’t have enough time to make volatility worth the risk. For that reason you should focus on ways of earning a return from investments that have minimal volatility.

Mid-term investments

In the mid-term you’re probably still going to want to take caution and make sure you don’t have all your eggs in one basket. The focus here should be on conservative funds, balanced funds or cash, depending on the flexibility of your goal.

“The amount of risk you may take in this medium term really comes down to the flexibility of your goals,” says Anderson.

For example, if you’re buying a house in five years but you can delay it by one or two years, then you may be able to afford to take on more volatile investments. That’s because if the stock market dips in five years before you buy you can always delay the purchase until it’s recovered.

“During the mid-term I’d look at conservative and maybe balanced funds plus cash depending on what your goals are.”

Ungaro recommends a slightly more aggressive approach and says it’s possible to successfully invest in equities and other high-risk asset classes in the mid-term as long as you’re diversified. “If you’ve got more than five years you can start to use diversification to de-risk your investments during that time frame.

“There’s no one rule when it comes to diversification, but I often work on this framework. I’ll have my core investment, 50 to 80 per cent in managed funds or a low-cost index. Then I’ll have 10 to 50 per cent allocated towards buckets which I call satellites.”

This might be 10 per cent in shares in individual companies, 10 per cent might be semantic ETFs (like AI, blockchain, robotics), and 5 to 10 per cent in crypto currency, and 5 to 10 per cent in a commercial property fund, for example.

Long-term investments

When you’ve got seven to 10 or more years until you’ll need the money you’ve got time to take a little risk, so sit back and let your money do the hard work for you. Your investments might include individual shares, growth funds or even aggressive funds (which generally hold all growth assets like equities and very few income assets like cash or bonds).

You could even take a punt on alternative assets like crypto, NFTs and others, but Anderson recommends doing so with care.

“There are known asset classes like cash, shares and bonds that we fully understand and have centuries of data around them. Then there’s emerging assets like NFTs and crypto. They’re just so unknown, they’re not proven or matured. They may be a game changer, but they could also be nothing and there’s a lot of risk with that.”

Again, even when investing over the long term the key is to diversify and if you’re going to take big risks on unproven investments it’s usually best to make sure they only make up a small percentage of your portfolio. There’s no hard rule, but 5 per cent could be a good place to start.

Controlling emotions

The S&P 500 dropped 19.4 per cent in 2022, a sign of a wider market slump that’s hitting investors and KiwiSaver balances. This year economists are agreeing that NZ is most likely in recession already and this is expected to last until 2024.

That means investors could be in for more hard times as the markets react to these tightening economic conditions. The guidelines and principles detailed above should still hold true for most, but Anderson says many will avoid investing completely during this time.

“The hardest thing right now is that your instincts are telling you don’t invest, it’s too risky. But if we look back to the GFC many of those who had cash flow and invested it consistently put themselves in really good positions to make good returns.

“If you can control your emotions and make small but consistent investments, regularly, over a long time it’s possible you could do the same.”