SMS 161 – Understanding Risk

Understanding Risk

Risk should be assumed as a means to solving a life problem. You should only assume financial risk to improve your financial situation

Is personality driven, people fall into one of two groups in all aspects of their personal finance lives, risk of doing something or the risk of not doing something.

Risk is relative to you and only you – someone else’s moderate risk could be your extreme risk. Some factors that would influence your specific risk level are:

  • Level of income
  • Debt level
  • Net worth
  • Age

Example:

Action: Buying a house comes with the added risk of assuming the largest debt you will ever have and the risk that you lose your ability to earn income to repay that debt.

In-action: The risk of not buying the incredible wealth building tool that a house is, is that the housing market will continue to inflate and you won’t be able to qualify for the largest debt you will ever have.

When faced with important financial decisions, ask yourself the following (Forbes):

  1. What is the worst-case scenario?
  2. How will my life change and who is impacted by the wrong decision?
  3. What potential remedies are available?
  4. What would have to happen to bring me to a difference decision? In other words, to recognize that the risk is too great for the potential reward.
  5. Who can provide me with more information before I make my decision?
  6. Can I live with the regret regardless of my decision?

Managing risk is really about managing emotion – you are really trying to manage your reaction to possible outcomes:

  1. Perform arisk assessment when faced with a decision
  2. Risk should be calculated and absent of emotion whenever possible.
  3. Risk should be offset with potential rewards
  4. Risk is minimized by not being married to very specific outcomes

Risks you should take:

  1. Getting an education – student debt vs increase in income
  2. Relocating to a city – higher cost of living vs more opportunities
  3. Buying a house – risk of not being able to repay your mortgage as well, the housing market
  4. Investing – risk of losing money vs building wealth
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