Managing Personal Financial 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.
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.