Financial Risks – Taking too much Risks
Financial Risks – Taking too much Risks
- Not Saving Enough
- Buying High-Cost Investment Products
- Taking too much Risk
Taking too much Risk
This is a common blind spot in 2019, quite different from the appetite for risk in 2008 and early 2009.
What Risks?
The first step in investment is to identify the events which may trigger a financial risk. Most families face risks to personal lives, property risks and liability risks.
Personal risk is the loss of income and, possibly an increased expense pattern as a result of unemployment, illness, disability or premature death. Property risk is the loss of personal property in one’s household and real estate which could be caused by fire, wind, accident, or theft. Liability risk involves loss as a result of neglect or carelessness resulting in bodily injury or property damage to another person.
Prioritising Financial Risks
Once identified, you can prioritise your risks within each category on the basis of financial severity and the probability of their happening. Also some risks may be more manageable than others, while some risks may pose significant financial impact but their probability of occurrence is very low.
Identify the Risk
Identifying risks is more important as they play an important role in helping you meet your goals. Without providing for them the goals may not be met easily. Identifying and prioritising the risks become important so that you do not miss out on the crucial risks at any stage of your life. At times you may minimize the risks, accept or share a portion of the risks or may even transfer them.
The key reasons for this blind spot are:
1. Believing clichés such as Invest hundred minus your age in Equity
This rule says If you are 30-year-old you should not invest 70 per cent of your net worth in equity which need not be followed hence it does not work for all. The investment limit differs from person to person.
Practical Problems with this Rule
This rule assumes that financial planning is the same for everybody. Investing decisions should be based on your financial goal, your current assets, current liabilities, future plan, income potential, and unforeseen additional factors. If you are nearing to your retirement age, and not planning on taking withdrawals from your retirement accounts until you are required to do so at age 70 , then your money has many more years to work for you before you’ll need to touch it. If you want your money to have the highest probability of earning a return in excess of 5% a year then having only 50% of those funds allocated to stocks may be too conservative based on your goals and time frame.
On the other hand, you might be in your early 60’s, and about to retire. In this situation, many retirees will benefit from their retirement saving plans or they can also opt for re investment. In this case, you may need to use a significant amount of your investment money in the coming years, and perhaps more allocation of funds towards equity stocks would be too high.
2. Taking High Risk to meet Goals
If you have saved less than you needed to (let’s say for retirement), then you are naturally more desperately in need of high returns and hence you may be tempted to take more equity risk. But if you did that and in the rare event that the stock market crashes by say 50 per cent, then you would not be able to meet even your basic needs such as paying your rent during retirement. So, such a person does not have the financial cushion to take high risk and hence she/he should take less risk.
3. Falling for the Myth
‘Equity is safe in the long-term’ Over a 5 to 10-year horizon, there is a higher probability that equity will at least match inflation. But there is also a material probability that it will generate returns that are lower than inflation.
For example, a household with double income will be in a financially better position to mitigate the loss arising as a result of loss of income of the primary breadwinner compared to a family with a sole breadwinner. A second wage earner in the family is one way to protect against complete loss of income.
When you accept any risk, you may begin savings to fund those unforeseen risks or maybe buy a health or a pure term insurance plan to tide over any unforeseen calamity.
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