Understanding risk

Sylvia asks: I’ve got R500 000 to invest over a five-year period. We will be retiring in about six years’ time and we don’t want to use this money, so we need something that will grow aggressively.

What do you think, retail bonds or shares, which is the safest way to go?

Maya replies: What is interesting in your question is that you want to know the safest way to go but need to grow aggressively.

This raises the important question of what defines risk. In the short-term (three years or less) your risk would be market volatility. In other words the market could move negatively and wipe out a portion of your capital. However over the longer-term (five+ years) your biggest risk is inflation.

We know for a fact that each year the value of your money will decrease by the rate of inflation. Currently that rate is around 4% but it is expected to climb to 6%.

While that is the official inflation figure, for retirees the rate of inflation is often higher because medical costs make up a higher percentage of your monthly expenses and medical inflation runs at about double the rate of normal inflation.

Over the longer term the equity market is the only way you can protect against the risk of inflation.

Although there is no guarantee in terms of returns equities, or other growth assets like property, are your only fighting chance against inflation. Over the longer-term cash actually has a higher volatility risk as interest rates move in cycles of usually around five years. So pensioners who were relying on interest income over the last five years have seen their income drop by over 30%.

Retail bonds are in effect a cash-like return as it is linked to interest rates. Currently the RSA Retail Bond is paying 8% for a five year investment while Nedbank’s Retail Savings Bond is offering 8.75%.

If the Reserve Bank is able to contain inflation at a maximum of 6%, this will give you a return 2.75% above inflation risk-free which is a good option. The risk is that inflation moves significantly above this level.

If one looks at historical market returns, over a period of time you can expect around 5% above inflation from a balanced fund. If you look for an equity (shares) investment such as a unit trust, it would be best to opt for a good quality balanced fund where the fund manager has the ability to move between asset classes, especially during more volatile global conditions.

My recommendation is that you meet with a financial advisor and understand your financial position with regards to your retirement plans. Do you have enough to retire on? What is the strategy with your existing retirement money? How does this lump sum fit in with that strategy?

This close to retirement you need to look at your money holistically.

Read more news, blogs, tips and Q&As in our Smart Money section. Post questions on the site for independent and researched information


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