9 Important Tips for Managing Financial Risk

Internationally-known daredevil Karl Wallenda earned his fame by performing acrobatic acts high above the ground — without a safety net.

For years, Wallenda had performed his dangerous stunts countless times without incident, but on March 22, 1978, his luck finally ran out. While walking 121 feet above the pavement on a high-wire stretched between two towers of a Puerto Rico hotel, an unfortunate combination of improper rigging and strong wind gusts tripped up the 73-year-old Wallenda, and he fell to his death.

Wallenda isn’t the only daredevil who has taken giant risks in life — there are personal finance daredevils who fail to properly manage risks too. And while there is nothing riskier than putting one’s life on the line, it’s still extremely important to understand and effectively manage the financial risks we face in life.

Risks are typically managed in one of three ways:

  1. Off-loading the risk onto somebody else.
  2. Hedging the risk.
  3. Doing nothing and accepting the risk as is.

The decision on which of those three options to employ is usually a factor of how much money you are willing to spend to mitigate the risk, and the level of risk you’re willing to accept.

Here are some of the most common ways you can properly manage financial risk:

Carry the proper amount of insurance

Insurance is supposed to protect you from losses you can’t afford to replace — it isn’t meant to cover smaller expenses like a fender bender, or minor roof repairs. Keep that in mind before paying higher premiums in exchange for lower deductibles.

Maintain adequate emergency funds

Keeping dual emergency funds provides a rock solid hedge against the unexpected. So keep a small rainy day fund to help weather short-term, low-impact financial storms of less than $2000, and a larger separate emergency savings account with three to six months of living expenses for longer-term crises such as a job loss or medical issues.

Diversify your investments

Diversification is a critically prudent and important financial planning strategy. And although it won’t eliminate losses in a severe downturn, it will reduce your risk of financial annihilation. Maintaining a well-diversified balanced investment portfolio helps minimize risk by spreading out your investments across multiple classes; think of it as a form of free investor’s insurance that protects you from catastrophic losses. If you’re unsure of how to diversify then it’s best to leave it to a portfolio management professional.

Have a second source of income

Diversity isn’t just important for your investments — it also pays when it comes to your income. The best way to protect yourself from an unexpected job loss is to find an alternate source of income. Perhaps you can start up a side business doing something you enjoy in your free time. And if you’re really lucky, you may be able to find a way to earn additional money without even having to leave your home.

Have an exit strategy for every investment you make

You can’t guarantee an investment will be bought at the optimal price, but, if you’re smart, you can always control how much you ultimately lose. The best way to do that is by taking emotion out of the equation. So have an exit strategy in place whenever you take a position on a stock, bond or any other investment. The best way to do that is by establishing predefined selling points — for both a profit and a loss.

Maintain your health

I’ve been told more than once by my doctor that staying physically fit is the cheapest health insurance available. We can significantly minimize our risk of disease and other physical ailments by simply exercising and maintaining a healthy diet. I know. This one is easier said than done.

Always read the fine print

Tom Waits once said, “The big print giveth, and the small print taketh away.” Whenever you’re reviewing a contract, make sure you read the fine print; it usually contains language that gives the other party an advantage in the event of a dispute — and that can end up costing you big money.

Stay employable

Everybody can be replaced — well, except for the guy who figured out a way to make himself indispensable to his employer. Don’t rest on your laurels. Constantly challenge yourself. Never stop learning. And always volunteer to take the difficult and/or dirty jobs that nobody else wants.

Keep your debt to a minimum

Taking on excessive debt greatly reduces the wealth you can accumulate down the road. By staying away from excessive debt you’ll not only maintain more control over your life as you get older, you’ll also avoid the chains that prevent you from ever attaining financial freedom.

Remember, when it comes right down to it, life is a financial high-wire act, so prepare appropriately. After all, sometimes even the luckiest daredevils eventually end up wishing they had a safety net.

Photo Credit: Baynham Goredema



Comments

    • 2

      says

      The only way I will ever be able to be financially stable is to develop another source of income.

      I have put hours and hours of thought in to how to generate more income but all I can come up with is working part-time at Tim Horton’s.

      Looking for suggestions for someone with limited talent and skills outside of what I do at work for 40 hours each week.

      Having no luck finding a sugar daddy.

      • 3

        Spedie says

        Jane: Take the second job at Tim Horton’s. I have learned that it is not always the JOB that matters, but who you MEET while you work THERE.

        Keep your communication skills and gift of gab up, as well as a positive mental attitude – and you just may attract a job more desirable.

        Worked for me…

  1. 4

    says

    I’m big on risk management when it comes to investments. some of the articles I have recently posted on the Wise Dollar are specifically about managing risk, especially with the record high’s that the DOW is floating around in. Although I’m pretty good at managing investment risk, I need to tackle some of the other areas you’ve covered here.

  2. 5

    says

    I disagree on keeping debt to a minimum. As you’ve talked about Len, I think the federal government is going to have to inflate the dollar quite a bit to pay for their debts, and there’s nothing better than owing people a lot of dollars when dollars become very cheap.

    I’d rather be holding physical stuff (real estate, precious metals, etc.) which will retain value through a dollar collapse.

    • 6

      Len Penzo says

      Here’s the thing, Kevin. While I’ve written why I think economic collapse is practically inevitable (right now, I’d peg the odds of it occurring at 95%) — I can’t say with certainty when it’s going to happen. It could happen sooner rather than later — and I suspect it will — but what if the Fed manages to drag things out for a lot longer than we expect? Remember, the final collapse won’t occur until enough people wake up from their stupor. In a world where most people can name the host of Dancing with the Stars, but have no clue who Ben Bernanke is, collapse could take awhile. And a lot could happen between now and then — like a catastrophic loss of income.

      For that reason, I refuse to take on the added risk of having too much debt — and neither should most people.

      (That being said, if I didn’t have a wife and kids I was responsible for, I would probably be leveraged to the hilt.) ;-)

      Disclaimer: Please, folks, that is not to be taken as investment advice.

  3. 7

    says

    Wow, that’s a pretty thorough list Len. One thing that strikes me: Of the nine tips you list, I think the relative importance varies depending on age, family situation, etc. For example, life insurance is probably very important for a wage earner with a fat mortgage and lots of kids. But it’s less important for a retiree. (In general, I mean.) Most of us don’t start thinking seriously about maintaining health until we either have health challenges or reach middle age I think. This one’s getting even more important for middle-aged folks and beyond because, with the huge deficit in retirement savings nationally, many will need to be physically able to work into their 70s.

    Thanks for the thought-provoker!

  4. 11

    says

    These are all good ideas, and diversifying is especially smart to do. I also think having tangible assets such as precious metals, a paid for in full vehicle, and even a storage of food in case you hit hard times. These things will always have value.

    • 12

      Len Penzo says

      Good points, Melinda.

      Precious metals should be part of a balanced portfolio (covered via investment diversity) although, technically, I consider gold and silver to not be “investments” per se — they’re main role is to preserve wealth that you’ve already accumulated. But if the price of precious metals end up rising in dollar-terms, then hey — that’s a bonus.

  5. 13

    says

    Awesome post and one that reminded me of why we do what we do. It’s so important to make sure the overall picture is taken care of not just ‘debt’ per say. There is more to life than saving money. We just had our life insurance reduced by 50% this month because we quit smoking one year ago and are very happy. Keeping healthy is very important to us now as is making sure we have a plan B. Lots to think about, thanks for the reminder here.

  6. 14

    says

    One thing I found in Investing is that it’s relatively easy to buy than to sell. Instead of taking a profit of $5,000, I waited till I lost all my $27,000 originally invested. I waited and waited and waited till it was too late.

    I did not have an exit strategy for my investment.

    • 15

      Len Penzo says

      I’ve made a similar mistake in the past — which is how I learned about the importance of having an exit strategy! I didn’t lose my entire investment, but I lost more than I should have because I was afraid to catch a falling knife.

      Nothing beats the school of hard knocks when it comes to learning a lesson.

  7. 16

    Rose says

    Thank you Len. I always appreciate you giving of your own time to help us out. Always great thoughts that make this house stop and think…. And for that we thank you.

  8. 18

    says

    That list touches great points. Great stuff. I like what you said about having an exit plan for every investment. And you make a great point when you tell us to maintain our health.

  9. 19

    says

    Taking a risk is what life is all about, yet the majority of people will stay in their humdrum routines day in and day out and wonder why life passes them by…always a little jealous of the successful people and those who have money. Yet how did the rich and successful individuals acomplished their goals? ….They followed their dreams and they had the…..

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