How can you make really smart decisions and take less risk ? Don’t get me wrong. Risk is a good thing. It keeps us motivated, focused and scared and allows us to experience a crazy rush from time to time. It’s what keeps us safe at night and helps those retirement accounts grow. It makes us consider our life insurance beneficiary and the importance of estate planning. This article is going to elaborate on what people mean when they talk about risk. Pretty standard, or so you think.
I have seen risk defined many different ways, and at the end of the day each definition gets boiled down to that boring adage, the bigger the risk you take the bigger the potential reward. Then I came across one that split risk into four aspects and hit it pretty much on the nose. We are going to think of risk in a more personal way. The goal today is to try to increase your risk awareness in order to make better decisions.
The four sub-categories of risk can be boiled down to:
a. The risk that is required to earn the return that you need to reach a goal (standard start).
b. Risk that you perceive in the world – it’s really how risky something might feel on your internal meters.
c. Your risk capacity (how much can you afford to lose).
d. Your risk tolerance.
Now looking at all four of those, you might be saying to yourself, “Hey this Nunzio guy has no idea that he just defined the same word four times.” Really though, what I am trying to do is to show you that risk can mean very different things to each of you at different times. The trick is to apply the right definition at the right time.
I urge you readers out there: when you’re thinking about your next decision, whether it is inside the portfolio or for a new kitchen top, think of these four nuances because there is risk and opportunity cost associated with everything.
If you decide NOT to do something, it’s because you decide the risk isn’t worth the reward. Think about a business proposition. If you decide you don’t like the prospect of being self-employed, is it because you are concerned about the risk? But is the risk real or imagined? Do you need to become better informed or do you need to back away?
Identify the risk and you’ll know what you need to do next – and it won’t always be to say “no.” What that means is if the timeline for your retirement fund is 40+ years, you can afford to be a little higher on the risk scale because you have time to ride out the ebbs and flows of financial markets. But in any given year, you may not have the risk tolerance to do it. That’s the conflict that only you can reconcile – and if you ignore the need to reconcile that divergence, you do so at your own peril.
The money set aside for that kitchen countertop is probably in some kind of savings account where there is virtually no risk (no return) and it’s a short-term parking space before the granite countertops get delivered. You may be itching to get a better return (risk tolerance), but the reality is that you can’t afford to take any risk with money that really isn’t yours anymore.
When you are talking about money and goals, scenarios can change at the drop of a hat. That’s perfectly fine. Just make sure as you are bumping along life’s ups and downs that you keep your finger on the pulse that tells you when and where to take risks. In other words, don’t worry about learning how to become a millionaire unless and until you understand risk.
My hope is to at least get you thinking about risk in a new light. At the very least, whether you have assets in the markets or not, you are reflecting on how risky your assets are, how risky you need them to be and what the goals are for them. Remember, just because you feel comfortable doesn’t mean you are making the right decision. And just because you are doing the right thing intellectually doesn’t mean it’s the appropriate choice for you.
It’s a balance you have to be in constant search of.
To find more of me, feel free to stop on by http://www.financiallydigital.com where, like the Wealth Pilgrim, I try to help you get as much out of your financial life as possible!