Warren Buffet said, “Risk comes from not knowing what you’re doing.” Isn’t it interesting that the same could be said about “Fear?” Everyone has a slightly different relationship with risk. We are the sum total of our experiences or lack of experiences which have led us each to a precise point in life. Some of us thrive on risk. Some of us do everything we can to avoid risk. And the majority of us are somewhere in between this million mile range.
The reality is that risk is everywhere! 24 hours a day we are exposed to it even when we are doing nothing. We risk our health, our livelihood, our financial picture, our future and sometimes our relationships. None of which you don’t already know, but sometimes it is good to have a reality check.
The real question I want to address today is, “What can I do about it?” You basically have three options…or maybe four if you include “Just take it” as one. But let’s discuss the other three.
First, you have the option to avoid it. The problem with avoiding risk is that it always exposes you to other risks. Take, for example, a child’s health. You hear many young parents talk about keeping their children out of pre-school or similar environments to keep their young toddlers healthy. This works fine and dandy until Kindergarten. An experienced parent will tell you that this can make the first year around germs a disaster year full of sickness. Now think about your money in the same respect. You lock your greenbacks in a fire proof safe at home. What risk are you taking now?
Hint: Does food or clothing cost more than it did 10 years ago or even 5 years ago?
Bingo! Inflation is a huge risk. If inflation is currently 4%, $100 this year is only worth $96 next year. So if you spend a $100 at the grocery store next year, what will you put back on the shelf? For this reason we call avoiding risk “going broke safely.”
The second option is to transfer risk. This is what you are doing when you insure your house. If you didn’t have insurance and your house burnt to the ground, it might be devastating. So, most of us insure our home. Transferring risk when it comes to your investments may be insuring your retirement income or insuring a certain value of your investments at some point in the future. What is the downside of transferring risk? Cost! We all know if it sounds too good to be true, it probably is. Well, who wouldn’t want to guarantee their retirement income? You can do it at the guarantee of the guarantors, but it is going to cost you to do it in both dollars and time. Which is where things get hairy: You better know exactly what you are getting into and have someone help you weigh the “what ifs.” Through our years of experience we have seen some really bad guarantees that are no better than avoiding the risk and in some cases, worse. We have also had people come to us not able to get to their money because they didn’t understand what they were getting into. Just to be clear, I am not “anti-risk transfer,” but I do believe in proceeding with caution with risk transfer.
Last, you have the option to manage risk. Wisdom is more powerful than knowledge. Managing risk is simply following conventional wisdom such as: “Don’t put all your eggs in one basket,” “An investment in knowledge pays the best interest”—Benjamin Franklin, “Be greedy when others are fearful and fearful when others are greedy” —Warren Buffet, or “When it comes to investing, buy often.” We call managing risk the “t-ball” approach. It isn’t perfect. You aren’t trying to hit home runs, but you aren’t getting struck out either. The risk is primarily YOU and YOUR EMOTIONS. Most of us have a problem being patient and managing risk can be like watching paint dry. It can be a somewhat boring option. But if you fall into the in-between range of risk solution, it might be your best option.
The bottom line is risk is not black and white. With every option comes its own inherent risk. This is why it is so important to not try to do the job alone. Work with someone who not only has the experiences of good and bad with all types of risk, but someone who knows YOUR unique situation, future and goals and family dynamics.
Disclosure: Diversification (Asset Allocation) does not does not guarantee a profit or protect against loss. Dollar Cost Averaging does not ensure a profit or protect against loss. An investor should consider his or her financial ability to continue to invest in a period of declining markets. The guarantees of fixed (life/annuity) contracts are contingent on the claims-paying ability of the issuing insurance company.