I know, you may be burned out on risk at this point. You may be saying, "Craig, I'd rather hear about late '90s sandwich franchises or emergency savings!" Well, that's just too bad. Risk is arguably one of the most under-represented considerations in life, let alone personal finance. And, despite thousands of words of dope content, I still have more to share! This week, let's drill down into how to find an appropriate risk profile for you.
This image came up under "risk" because... she's posing for a picture instead of working?
Debt
I dedicated the majority of this series talking mostly about your investments. What about debt? Of course, debt is a major part of your risk profile. When you choose to borrow money - for a house, car, student loans, or even just charging everyday items on a credit card - you are taking a risk. Debt can follow you your entire life, impacting your ability to borrow money in the future and even force you into bankruptcy.
In making financial decisions, you should always consider if your choice will lead to taking on more debt. Yes, that sounds obvious, but here's a hypothetical. Say you are 55 years old, have your house paid of nearly all the way, but are light in disposable income and want to take your dream vacation to Iceland. You read a digital ad on MySpace for a cash-out refinance option at a historically-low interest rate. You decide the northern lights and fermented shark can't wait. You fill out a quick application, sign some documents, and all of the sudden you have $25,000 in hand to blow on over-priced wool sweaters and healing spas. Was this money just free to you? Of course not. You essentially took an illiquid asset (your house), sold off a piece of it, and are slowly paying it back (with interest). All this said, was this okay to do? Depends. Let's say you are making a great income, have plenty saved in a 401(k) to live comfortably in retirement, and have no other debt. Then, certainly, this is not a life-changing decision. But what if you had nothing saved for retirement, were pulling almost all of your equity out of your house, and had mounds of other debt? A different story altogether.
Risk in the Big Picture
Last week, I discussed risk when it comes to individual investments like buying a house vs. investing in the stock market. Of course, understanding the risk, reward, and liquidity of these decisions is important, but so much depends on you and your life situation. Let's step back and analysis risk when it comes to everyone's financial decisions.
Using the example from above, minus the $25,000 Icelandic adventure, but keep the house, solid 401(k), and more other debt. At age 55, you are hopefully planning for retirement and have a good idea of how close you are to your financial goals. But let's look at your circumstances more globally. If your goal is to retire at 58, but all your money is tied up in your house and 401(k), you may be in a pinch! Do you have enough liquid savings to carry your through to 59 1/2 where you can access your 401(k) without penalty? What if you plan to sell your house - do you have enough for a down payment on the next place you buy?
Your financial calculus will change depending on your life circumstances. Going to the other end of the age spectrum, pretend you're in your 20's and are early in your lucrative career. You may have few obligations outside of the basics, but you have long-term goals of retiring at 45(!) and buying a 10,000 square-foot estate in the mountains. Realistically, this is not likely to be achieved, but you are willing to buckle down now to take your best shot. The temptation is to max out your risk - taking every available penny and plugging it into the next-up crypto with the hopes of hitting the jackpot. Now, is this a justifiable chance to make it big? Nah. It's a silly get-rich-quick gamble where you risk throwing away everything. Instead, you can mitigate the single-threaded nature of your risk and still realize strong gains without as much risk. For example, you could buy an aggressive ETF that invests in cutting-edge medical technology. While the risk remains, it's spread across multiple companies/stocks where you can buy into the approach rather than just one prospect. Even better, you could buy into several, similarly-aggressive ETF's that spread the risk even thinner without losing the potential gains.
Achieve Balance
Whatever the situation, the real key is achieving balance in your assets to take the appropriate amount of risk for your circumstances. Despite what some may tell you, there is no magical formula for determining how much risk a person should take with their assets. Your life circumstances will dictate much of how much risk you should tolerate, and will change over time. As I wrote about a few weeks ago, time is so important to your investment considerations – just don’t pull a Frank and try to make up for lost time with risky bets!
Regardless of your personal situation, though, you should strive to have a balance of low- and high-risk investments, and well as a balance of liquid and illiquid. Have a rough idea of what money you could access immediately in case of emergency… yep, back to emergency savings! What you don’t have saved for emergency savings and your day-to-day expenses should be invested in something – stocks, bonds, CD’s, real estate, your business, etc. Let your money work for you, but be cognizant of how much risk you’re taking and if your life has changed enough to reconsider your investments. It's all about balance.
Believe it or not, there's more to talk about with risk! Calm yourself. We haven't even talked risk in your career. That's our topic for next week. If the last GIF inspired you to dust off those old blades and hit the pavement, enjoy the weather and we will call it for this week!
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