Learning the difference between credit and market risk

THE collapse of Banksia Securities will not have a big effect in Queensland because it was a relatively small institution and was based in Victoria.

Noel Whittaker

THE collapse of Banksia Securities will not have a big effect in Queensland because it was a relatively small institution and was based in the north of Victoria.

However, the lessons are a warning to all.

Banksia was not a bank - it was an unlisted non-bank lender that became heavily involved in lending to development projects.

It was able to offer a higher rate of interest to its depositors because it was charging high rates to its borrowers, but anybody chasing high rates needs to remember the adage "the higher the return the higher the risk".

It now appears that bad debts will bring it down, and depositors will not get all their money back.

There is a difference between credit risk and market risk.

Credit risk means the chance that you won't get all your money back, market risk means the risk that the value of your investment can fluctuate.

The first is relevant to interest-bearing investments such as mortgage trusts and bank deposits - the second is relevant to property and shares.

Even though cash type investments are traditionally regarded as less risky than shares, my preference is for shares.

For example, if I buy an index fund I will get a running yield no matter what happens, and I know that at some stage in the future my asset will recover in value if it falls.

However, if I place money in a debenture, and the company fails I may get nothing back at all.

To make matters worse, the funds may be frozen for years while the receivers sort things out.

* Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions.  For more information email [e-mail].