In general, with any investment, the greater the risk you take, the greater the potential reward. Over time this has meant that people who have invested in the stock markets gained more than those who went for safer options such as government bonds or bank deposits.
However, people may not be comfortable taking what they perceive as high risks with their pension savings. How can people determine how much risk they are willing to take and what are their options if they want to preserve the value of their hard-earned savings?
Equity, bonds, or cash – what’s the difference?
Looked at from a one-to-two-year perspective, the stock market can appear volatile, says Kevin Quinn, chief investment strategist, Bank of Ireland.
“The way the public equity markets work is that they try to embed all the information that’s going on in the world economy in a very short period, so we tend to see lots of volatility in the short term,” says Quinn. “In the longer term, that tends to work its way out of the system.”
Essentially, the stock market is a longer-term option for investors. For a pension fund investor, the majority will think about investing for at least 10 to 20 years. “The longer time they have, the more heavily they can be invested in the equity market,” says Quinn.
By buying bonds, you’re lending money to a government or company and getting an interest rate from them that is dependent on the level of risk associated with the entities that issue the bond. So a low-risk government bond from, say, Germany or France would attract a relatively modest yield, whereas other sectors and companies offer much higher yields.
“The return tends to be reasonably predictable with bonds,” says Quinn. “Although that’s not always the case. The last couple of years haven’t been as good a time for bonds.” Big moves in interest rates can affect the value of bonds – Quinn says we saw that in sharp relief in 2022.
Bonds play a role as a diversifier, he adds; they tend to perform in different ways to the equity market, so that when one is down investors hope to get some sort of buffer from the other.
“At the moment, because we’ve been through an unusual period of elevated inflation, yields on bonds are relatively high and going up,” says Quinn. “For a would-be bond investor in the European bond markets, it would not be untypical to see 2-3 per cent from relatively low-risk issuers.
“Similarly, in the US, oftentimes in international markets the 10-year Treasury [rate] is seen as the most important interest rate on the planet and it’s just under 5 per cent at the moment.”
So there is quite a lot on offer from the bond market as well, he says.
“Certainly, investors who are getting closer to retirement can benefit from that,” adds Quinn. “You have choices now at the point of retirement.
“For those who have personal or company pensions, the choice can be to put your pension into an approved retirement fund and they may decide not to take income in the first few years of retirement. These assets present an ongoing consideration for what investors would do with their cash.”
Cash is the third option when it comes to investing. “Cash speaks for itself. It’s what rates are available, and it’s to some degree a function of what’s happening with the ECB or, on the other side of the pond, the Fed,” says Quinn.
“Interest rates have been going up of late in response to the inflation problem. Expectations are that we’re at a plateau in Europe and we may yet see another interest rate increase in the US. It means that cash rates are quite high by historic standards.”
When deciding whether to invest in the stock market, assessing your risk tolerance is crucial, says Nicholas Charalambous, managing director, Alpha Wealth.
“Consider factors like your age, financial goals and comfort level with market volatility. High-risk investments can yield higher returns but they also carry more significant potential for losses.”
Mitigating risk
While there is no real way to mitigate stock-market risk, Quinn says one should take a reasonably diversified approach to the market and not be over-concentrated in individual stocks, sectors or styles (how certain parts of the equity market respond to outside economic influences).
“For example, if someone had been an equity investor in 2022, it was a tough year,” he says. “Equity markets went down. But because we had interest rates rising and inflation in the system, if you had elected to be very concentrated in the technology sector you lost heavily.
“By contrast, if you had the foresight to pick energy stocks when the problems happened with the energy crisis in 2022, energy stock prices were significantly ahead of other sectors that year. Conversely, for most of this year, it’s been the reverse. Oil prices came down for most of this year and, largely as a consequence, energy stocks didn’t do that well.”
“For a good while, we’ve had the prospect of interest rate cuts on the horizon, which has a knock-on effect and benefit on technology stocks.”
Getting the right advice
When you meet a financial adviser it is important that your risk tolerance is assessed; this is completed through a simple questionnaire they can provide you with, says Charalambous.
“This takes into account how long you wish to invest and will give you a risk rating number. All of the life/pension companies’ investment funds have a risk rating number which makes it straightforward for individuals to ensure that they are in the correct risk category.”