What Is Investment Risk? Types, Examples, and the Risk You Overlook

Investment risk is the possibility your actual return will differ from what you expected. It covers everything from a share price falling to your savings not keeping pace with the cost of living. Every investment carries some degree of it, and the relationship is straightforward: higher potential returns generally come with higher risk.

Most explanations stop at listing the types of risk. This one goes further. Below, we walk through the main categories, explain how New Zealand regulates and measures risk, and present the data on the single biggest risk factor for NZ investors: their own behaviour.

The Risk-Return Relationship

The risk-return trade-off is the foundational principle of investing. Cash offers the lowest expected return and the lowest risk. Shares offer the highest expected return and the highest risk. Bonds and property sit between the two. No legitimate investment offers high returns with no risk; if someone claims otherwise, treat it as a warning sign.

The FMA puts it simply: risk is what you get paid for through investment returns. When you take on more risk, you should be compensated with higher expected returns over time. Risk only becomes a problem when you accept more or less of it than your goals require, or when the expected return does not justify the risk taken.

Types of Investment Risk

Investment risk is often divided into two broad categories. Systematic risk (also called market risk) affects all investments to some degree and cannot be eliminated through diversification. Unsystematic risk is specific to a particular company, sector, or asset and can be reduced by spreading your investments across different holdings.

Here are the main types to understand:

Market Risk

The risk of your investment losing value because the overall market declines. Recessions, pandemics, geopolitical events, and shifts in investor sentiment can all drive broad market falls. Even strong companies lose value in a general sell-off. Market risk cannot be diversified away, but it can be managed through asset allocation and time horizon.

Interest Rate Risk

Changes in interest rates affect the value of most investments, though bonds are most directly exposed. When rates rise, the market value of existing bonds typically falls, because newer bonds offer better yields. For NZ investors, interest rate decisions by the Reserve Bank flow through to bond prices, term deposit returns, mortgage costs, and property valuations.

Credit Risk

The chance an issuer of a bond or other debt instrument will fail to pay interest or repay principal. Government bonds issued by stable sovereigns carry minimal credit risk; corporate bonds carry more, which is why they typically pay higher yields. Credit ratings (AAA down to junk) exist to help investors assess this risk before committing capital.

Inflation Risk

Also called purchasing power risk. If your returns do not exceed inflation, you lose ground in real terms even if your nominal balance grows. Cash and fixed-rate bonds are especially vulnerable. A term deposit returning 4% while inflation runs at 5% leaves you worse off in real purchasing power each year.

Currency Risk

New Zealand is a small, open economy and most diversified portfolios contain significant offshore allocations. If the NZ dollar strengthens against the currency your overseas investments are denominated in, your returns are reduced when converted back. The reverse also applies: a weaker NZ dollar boosts the NZD value of offshore holdings. Currency risk is an unavoidable part of global diversification for Kiwi investors.

Liquidity Risk

Liquidity risk arises when you cannot sell an investment quickly without accepting a significant discount. Listed shares on major exchanges are generally liquid; direct property, private equity, and some alternative assets are not. Investors usually demand higher returns from illiquid assets to compensate for the inability to exit on short notice.

Concentration Risk

Holding too much of your wealth in a single asset, sector, or geography magnifies your exposure to anything going wrong in that area. In New Zealand, this is particularly common among investors who hold most of their wealth in residential property and have limited exposure to other asset classes. Diversification is the primary defence against concentration risk.

Political and Regulatory Risk

Government policy changes can materially affect investment returns. In NZ, recent examples include the extension and then reversal of the bright-line test for property, changes to interest deductibility rules, and ongoing discussion around potential capital gains tax. Internationally, trade policy shifts, sanctions, and political instability all create uncertainty for investors with offshore exposure.

Longevity Risk

The risk of outliving your money. As life expectancy increases, the number of years your savings need to fund in retirement grows with it. This is a real and often underappreciated risk for New Zealanders, especially those planning to retire early. A portfolio built for 20 years of retirement may fall short if you live to 95. For more on this, see our article on why living to 100 is your greatest financial risk.

Sequence of Returns Risk

Two investors can earn the same average return over 20 years and end up with very different outcomes depending on when the losses occurred. If your portfolio suffers large declines early in retirement, while you are also drawing income from it, recovery becomes much harder. This is why many advisers recommend de-risking before retirement and holding a cash buffer for the first few years of drawdown.

If you are unsure whether your investment mix reflects the right level of risk for your goals, get in touch with our advisory team. We work with clients across New Zealand to build portfolios suited to their stage of life and risk tolerance.

How New Zealand Measures and Regulates Investment Risk

New Zealand has a structured regulatory framework for investment risk. All managed funds, including KiwiSaver Schemes, are required to publish a risk indicator in their Product Disclosure Statement (PDS). The risk indicator uses a scale from 1 (lower risk, lower expected returns) to 7 (higher risk, higher expected returns), based on the historical volatility of the fund’s returns over a rolling five-year period.

This gives investors a standardised way to compare funds. A conservative fund might sit at 1 or 2; a growth fund at 5 or 6; an aggressive fund at 6 or 7. The rating reflects past price movements, not a prediction of future performance, and a major market event can shift the rating.

The Financial Markets Authority (FMA) oversees this framework and publishes a KiwiSaver tracker allowing New Zealanders to compare fund risk indicators, fees, and returns. Sorted, the government-backed financial literacy service, also provides tools and guidance on assessing risk tolerance.

Some investors worry about whether particular fund structures are inherently risky. Jonny McNamee, Financial Adviser at Become Wealth, sees this regularly: “Clients sometimes assume PIE funds, KiwiSaver Schemes, or managed funds carry structural risk simply because they are pooled investments. In reality, New Zealand’s financial services sector is heavily regulated. Funds are held in trust by independent custodians, disclosure requirements are strict, and the FMA actively monitors compliance. The structure itself is not the risk. The real question is whether the underlying investments and the level of risk match your goals and timeline.”

Risk Capacity vs Risk Tolerance

These two concepts are often confused but they measure different things. Risk capacity is your financial ability to absorb a loss and recover. It is driven primarily by time: a 35-year-old with decades until retirement has far greater risk capacity than a 70-year-old drawing down. Risk tolerance is your emotional ability to sit through volatility without making a destructive decision.

The distinction matters because the two often point in different directions. A young investor may have high risk capacity but low emotional tolerance for watching their balance fall. If the portfolio is built only around capacity, they may panic and sell at the worst moment. In our experience advising NZ households, the most durable portfolios are built around the lower of the two measures, then adjusted upward as the investor gains experience and confidence.

The Risk You Are Most Likely to Underestimate: Yourself

So far, everything above is external: market forces, interest rates, inflation, regulation. The data shows the most damaging risk is none of these. It is the investor.

Emotional reactions to market movements, particularly the urge to sell after a fall and buy after a rise, have consistently proven to be the most destructive force in long-term wealth building.

Warren Buffett put it plainly: “Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

The cost of poor behaviour is measurable. The DALBAR Quantitative Analysis of Investor Behavior, a long-running US study, found the average equity investor earned just 4.3% per annum over a 20-year period, compared to 11.8% for a simple buy-and-hold approach to US shares. In government bonds, the gap was similarly stark: 1.7% for surveyed investors versus 8.5% for buy-and-hold. The difference was not explained by fees or fund selection. It was explained almost entirely by badly timed decisions to buy and sell.

The evidence from New Zealand tells the same story. During the Covid-19 market sell-off in early 2020, the FMA commissioned PwC to study KiwiSaver fund switching behaviour across 1.5 million members from seven providers. The findings were striking.

Between February and April 2020, 58,356 KiwiSaver members made 88,112 fund switches. The switching rate was 2.7 times higher than the same period in 2019. On 22 March 2020 alone, 6,156 switches occurred, equivalent to about 20 normal days of switching activity.

Of those switches, 70.5% were to lower-risk funds. Members aged 26 to 35 were the most active switchers, making 30.8% of all lower-risk switches despite representing only 23% of the sample. Bank KiwiSaver providers saw a disproportionate spike compared to non-bank providers. And perhaps most telling: only 9.1% of those who switched to a lower-risk fund between February and April 2020 had switched back to a growth fund by August.

Westpac, which processed 18,140 switch requests during the sell-off, reported in late 2024 that 27% of those members had never switched back. Their modelling showed the potential cost: a KiwiSaver member with a $25,000 balance who switched from a growth fund to a conservative fund on 20 March 2020 could project a balance of roughly $388,000 by 2054. Had they stayed in the growth fund, the projected balance was approximately $615,000. A gap of more than $225,000, driven entirely by a single emotional decision.

National Capital estimated the total value switched to lower-risk funds during the period was $1.2 billion. Only $121 million was subsequently moved back.

The FMA’s behavioural analysis identified several biases at play: action bias (the felt need to “do something”), herd mentality, loss aversion, and a short-term focus reinforced by emotionally charged public discussion about KiwiSaver at the time. The same patterns repeat globally in every market downturn. The NZ data simply confirms this country is no exception.

How to Manage Investment Risk

Match your asset allocation to your time horizon. If your investment horizon is 20 years or more, your portfolio can tolerate higher volatility because you have time to recover from downturns. If you need the money within five years, preserving capital matters more than chasing growth.

Diversify across asset classes, sectors, and geographies. Diversification does not eliminate risk, but it does reduce the damage any single holding or sector can do to your overall wealth. For most New Zealanders, this means holding a mix of domestic and international shares, bonds, and potentially property, rather than concentrating in one area.

Understand the fees you are paying. Fees are a guaranteed drag on returns. Over a 30-year investment horizon, even small differences in annual fees compound into significant sums. The FMA’s KiwiSaver tracker is a useful tool for comparing fee structures across providers.

Avoid decisions during a sell-off. The KiwiSaver switching data shows the cost of panic. If your portfolio is correctly allocated for your goals and timeline, the appropriate response to a market decline is almost always to stay the course. As Buffett noted:

“The stock market is a device for transferring money from the impatient to the patient.”

Work with a financial adviser. An adviser’s value is often greatest during the periods when you are most tempted to act emotionally. Having someone to provide objective, evidence-based perspective during market volatility is one of the most practical forms of risk management available.

Investment Risk in NZ

Investment risk is real, unavoidable, and necessary. Without it, there would be no return. The types of risk are well documented: market, interest rate, credit, inflation, currency, liquidity, concentration, political, longevity, and sequence of returns. Each can be understood, measured, and managed.

But the most consequential risk for most investors is not listed in any textbook. It is the decision made at the worst possible moment, driven by fear, herd behaviour, or the simple urge to act. The NZ data on KiwiSaver switching during Covid-19 puts a dollar figure on it: more than $225,000 over a lifetime for a single, reversible mistake.

Understanding risk means understanding yourself as much as it means understanding markets.

Become Wealth holds both a Financial Advice Provider licence and a Discretionary Investment Management Service licence. If you would like to discuss your investment risk exposure, or have your portfolio reviewed, book a consultation with our team.