The Truth about RISK

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Most people are afraid of financial risk; even the word risk scares the majority.  Look at the commercials for investment firms and financial planners; they don’t even mention the word, just tell you how strong they are (we know that is a lie), or how they are there to protect your assets (another lie).  If these folks were being truthful, they would tell you the following:

There is no such thing as a risk-free investment.  Your rate of return will depend upon your willingness to accept risk.  The real issue is not whether you want to take risks,  but which risks you want to take.

If there is one financial truth you learn from my posts, please learn the above statement.

In my opinion the greatest risk taken is by people who arrange their lives around avoiding risk.  These people are fooling themselves into thinking they can avoid the risk of life.

Once you accept the fact of risk as unavoidable you can then plan and manage risk.  Honesty with yourself is the starting place.  Look at your savings, your retirement accounts, your assets.  If you really take a look can you honestly say they are enough to take care of you during your 20-30 years in retirement?  Or, are you thinking, as soon as the kids are grown up or when we get this house paid for or there isn’t enough money to pay my bills now how am I going to save or any other excuse?  Because there is always something even after you get through all those events.

Now here is another one of those truths about money.  You can manage risk without severely curtailing your return.

The common advice about risk is as follows:

  • Keep your money in a bank because it is protected from loss by the FDIC; or
  • Diversify your stocks [usually by owning mutual funds]; or
  • Pay off all your debt including your mortgage; or
  • Perform asset allocation [usually on your mutual funds]; or
  • Buy insurance products because of the guarantee against loss; or
  • Investing in [stocks, real estate, options, commodities] is too risky; or
  • Get a good career and you will never have to worry about money.

All of these statements do one thing.  Allow you to pretend that risk isn’t there.  It is and you really need to face it.

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Emotional Risk

That get’s us to the second and perhaps more deadly part of risk; emotional risk.

Emotional risk is pursuing strategies that so unsettle one as to keep them from behaving rationally. For example, every time the stock market goes down significantly, many people sell their mutual funds/stocks because they fear more loss. Other people fear debt so much as to pay down their mortgages or put large down payments on their houses feeling like there is less risk in this strategy. Or others never consider strategies or self-employment because of an emotional attachment to a weekly paycheck or consistent earned interest.

I have been working with a potential client since Thanksgiving.  She called me.  She told me she had done her research and wanted to get an EIUL.  We spend much time making sure she understood EIULs.  But every time we got to that point where she said she was ready to purchase it, she called back and said she was not ready.  “I can’t get over the one column.”  [Every EIUL illustration has a worst-case column that assumes maximum expenses allowed under contract from the day you buy it and minimum guaranteed interest rate credit].  So eventually after several of these phone calls, she asked me if I had any other suggestions that had higher guarantees? So I sent her information on an annuity that guaranteed principal and guaranteed a 5% return over 10 years.  She called back and started to talk about what happens after those 10 years.  So we parted ways. She will leave the money in a savings account getting less than 1%.

She had got herself so tied up in potential risk that she ignored the current guaranteed loss on her money due to inflation.

Emotions are tricky items to deal with.  I am glad she did not buy an EIUL, because she has not done the emotion work to be happy with it.  That is a recipe for a financial loss.

Here is the point I want to make:

Risk is always there.  Do the work to learn how to manage it emotionally and have a strategy that works for you.

Accept there will be change and challenges ahead for you.  The more you get through those challenges, the more confidence you have in yourself and your decision making.
Photo: Tambako the Jaguar

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  1. Good post. I’m always amazed by people who have dead-end jobs that they hate, but they refuse to leave because it’s “too risky”. So instead they remain miserable and grind their souls into dust.

  2. Awesome post David and awesome comment MikeG.

    Maybe I’m too young and green to relate but I too wonder why people can’t seem to get over that “hump” when deciding to invest in non traditional investment vehicles.

    I suppose the big house brokers have done too good of a job marketing traditional investments as the “safe” and “correct” way of saving and investing for retirement. It’s amazing that even with less that remarkable results the past few years (with many people taking HUGE hits to their portfolios) people still line back up to reinvest in the stock market.

    Dave, what methods have you found that best lays out non traditional investments to clients and is most effective at getting them over that “hump”?

    • Glenn, I have tried many things. 1st of course is a rational discussion about what they are doing now, and how that works for them. Next, is a discussion about how other methods might work for them and solve their issues with the traditional ways [401K with mutual funds]. But the bottom line is that it is hard for some people to step out on their own. It doesn’t help that almost all the other strategies [real estate, EIULs, dividend producing stocks] that might work better for them have a lot of negative internet chatter.
      Ultimately, when thinking about money, it is the emotions that must be dealt with.

    • What risk? I thought risk was A board game? Seriously though I’ve always thought it was riskier to not do anything. As far as 401k’s are concerned I always thought they were the biggest risk!

  3. What gets me the most is that these big investment houses that advertise their mutual funds and trading services brag about their returns but in reality, the one in the relationship getting the real return is the investment firm.

    As Robert Kiyosaki has said, the true entrepreneurs and capitalists use these fears most people have and capitalize on them. That is exactly why the founders of these investment houses many times are multi billionaires! They pay the average Joe 3% but in return make infinite returns off of their capital.

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