Managing Personal Financial Risk

Table Of Contents

Life is Full of Risk
Risks of Financial Loss

Life is Full of Risk

Everything we do involves some sort of risk, of various types and magnitudes. Some of these risks may be very low and not the sort of thing that it pays to worry about very much, such as going outside and getting struck by lightning. Some risks may be quite likely, like the risk of defaulting on credit products when you cannot manage the payments anymore and are falling more and more behind each month.

With some of these risks, there’s only so much we can do about them, but we can usually do something. In the case of the getting struck by lightning risk for instance, we can stay safely indoors when lightning occurs, and we can also have medical and life insurance to protect us should we end up getting injured or killed by lightning.

Managing Personal Financial Risk We call this managing risk, and with a lot of risks, you can’t eliminate them entirely but you may be able to reduce the risk, which may include both looking to reduce the probability of the event occurring as well as limiting the damage should it occur.

Since so many things involve potential financial consequences, we can say that managing the risk in our lives and managing our personal financial risk often overlap, although there are particular risks unique to finances that need to be understood and managed.

Even seeking to manage our finances involves risk, the risk that we won’t be able to do so very well, either from a lack of understanding or ability or a lack of discipline and resolve if we do understand what needs to be done to keep our affairs appropriately managed.

On top of this, there are other prominent financial risks, such as losing our job, incurring major expenses that are difficult to manage or may have a serious impact upon our financial plans, the risk of property loss due to both our own actions and events that we can’t control, and much more.

All of these require our attention, to the extent that the loss may be reasonably foreseeable. If our planet becomes invaded by aliens who seize all our money and enslave us, that is a risk that isn’t reasonable nor anything we could do anything about, but if the world’s economy collapses, that’s something that would be foreseeable, and if we ever move close to something like this being possible, there are some things that we may be able to do in order to hedge the risks of this at least somewhat.

There are two elements to risk and both need to be paid attention to, and they are the probability of the event and the extent that it may have upon us and our financial situation in particular when it comes to financial risks.

We want to make sure that we put enough weight on these factors but we also need to make sure that we don’t overweigh these things either. If, for instance, we are worried about losing money, we might want to avoid the stock market, but this should only be done if the risks at the present time are objectively too high, meaning that we’re in a situation where losing money is more likely.

Personal preferences of risk ideally would be kept out of things, even though financial advisors do well consider this. The reason is a practical one. If we are going to be panicking anytime our portfolios drop in value, then this at the very least may affect our enjoyment of life, and may even lead us to make poor investment decisions based upon these fears.

If these changes are merely incidental moves, for instance pullbacks within a bigger upward trend, then this fear may not be reasonable, although in some cases it may be plenty reasonable if the market trend is moving against us overall.

We also shouldn’t worry about routine things like driving to work, provided that we are safe drivers with reliable vehicles, and giving up driving to work because we are a little afraid of accidents wouldn’t really make sense. It would make sense though not to drive when one is truly impaired or during a storm where road conditions may present unacceptable degrees of risk.

We need to be always aware of the extent of a given risk in order to decide whether to take it on, and we not only need to worry about the likelihood and repercussions of risky events, we also need to weigh them against the benefits of taking on the risk.

Both sides matter here, and this is why more risky undertakings often come with higher compensation to make up for the risk. This is not always the case though and there are some dangerous jobs that can at least be seen not to compensate workers for what they take on, like for instance working in a coal mine which is likely to lead to illness and death due to the working conditions.

If this is the only job you can get, then we might want to still chose it if the alternative meant going hungry and having no place to live, but there are pretty much always alternatives. These alternatives may mean less compensation though so we have to decide if the extra money, if there is any, is worth it to us.

This is an example of how we would proceed in trying to assess and decide risk, and once again, there are lots of things that do have some sort of risk involved and may require us to at least think about whether these risks are acceptable or not, taking everything into account.

Risks of Financial Loss

When we look at financial risk, this will always involve a risk of a loss of financial value, whether that be current assets or the potential for future ones. If we do work that has a high risk of injury, injuries that may lead to disability, we will at the very least want to have some sort of disability insurance so that we can at least mitigate the impact of such an injury.

If we are managing our investment portfolio, we may not want to put all of our money in bitcoin and just stay in the trade no matter what happens, or worse, but all of our money into a highly leveraged bitcoin trade where we would get wiped out if we hang on to it even through quite normal short-term movements in the price of this asset.

Very few people would even consider such a completely reckless use of their funds, but there are plenty of risks with investments that we take on without any real thought, such as holding on to assets regardless of how they perform over time.

We really don’t manage risk very well with our investments overall and the standard strategy virtually ignores risk, or at least any attempt to manage it in a dynamic way. Something may not be terribly risky at the time that we purchase it, but things do change, and we may be in something or in an environment where risks can really go up, such as holding long positions in stocks during a major decline.

A lot of this comes from the investment industry, who really don’t want us thinking much about these things and especially does not want us changing horses that much, because we are riding their horse right now. They especially don’t want us riding too far off of the beaten path because they have beaten it for is and it is their path.

When it comes to the risk of loss of property, we tend to be much more diligent, with the help of the insurance industry. Insurers are more than happy to make us very well aware of the risks out there and to sell us protection. Insurance is generally a good idea and even with all the marketing, many people are uninsured, especially when it comes to life insurance.

The two big areas that a lot of people have room for improvement with are the risks of poor financial management and investment risks. Managing investment risk is often the more challenging of the two by far, as this requires that we achieve an understanding of investment risk that requires both thought and effort to attain, and is outside the interest or even awareness of the great majority of investors.

Both of these risks involve the risk of misallocation, whether that be allocating our income to various things including both spending and saving, and how we allocate the money that we have managed to save.

It isn’t that difficult to understand how we could better manage investment risk, even though few people attempt to do so. We purchase investments with a positive expectation of a certain return which we deem to be sufficient at the time, and while our goal may be to stay in them for the long term, the investments themselves don’t care, and will perform according to circumstances apart from our own wishes.

Securities are very dynamic, with their value changing by the second, and from a risk management perspective, we need to manage risk dynamically and not just making our decisions about them once and for all at the time of purchase as we usually prefer to do.

The starting point in managing investment risk is to realize that things do indeed change, and in particular, their risk varies, and if we don’t pay attention to these changing circumstances, we will not manage the risk property, or actually, at all.

The real key is that even if you are investing for decades, and what you have invested in is expected to deliver a good return over this time, along the way the ride will be bumpy and we shouldn’t just cast off out of hand any ideas of attempting to manage the ride there.

It’s easier to figure out where we’re messing up with our spending and saving though, and if we spend too much and not save enough, we’re going to pay the price of a shortfall later, presuming that our savings goals are in line with our actual future needs.

Most often, our savings goals are in themselves not sufficient, and we may not be able to sufficiently save what we need and may need to just look to limit the damage down the road. If we don’t follow through though then even the best laid plans will fail.

There is a lot to think about when it comes to trying to manage our personal financial risk properly, and this goes way beyond just having enough insurance, even though that’s pretty important as well.

How well we do at this will matter, and will matter a great deal. Personal financial risk management is in fact an area that just about everyone can get better at, but this will never happen unless we think about these things enough and also make the effort to do what we can to help ourselves here.

John Miller

Editor, MarketReview.com

John’s sensible advice on all matters related to personal finance will have you examining your own life and tweaking it to achieve your financial goals better.

Contact John: john@marketreview.com

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