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.
Of course, 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’s 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:
- Off-loading the risk onto somebody else.
- Hedging the risk.
- Doing nothing and accepting the risk as is.
Which option to employ is usually a factor of how much you’re willing to spend to mitigate the risk, and the amount of risk you’re willing to accept — otherwise known as your “risk tolerance.”
With that in mind, here are the most common ways to 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.
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.
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 those difficult 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: Larry Lamsa