Risk is such a huge part of life. Every decision we make has an inherent risk attached to it, but most decisions are not something we give that much thought to. Maybe we should: the arguments around tiny habits and the difference they can make is certainly compelling, but at least for me I rarely think of these small things in terms of risk.
When it comes to finance, though, risk can start to feel like something that we have never dealt with before. And it is something of a different game. In finance, risk is predominantly thought of as the other side of the coin to returns. You make a decision about what to do with your money, invest it (including in real estate) and the chance of not getting the outcome you hope for or anticipate, is the risk.
In daily life, we all take risks all the time based on previous experiences and on trends that we know from others. It’s rarely possible to eliminate risks, rather, you can aim to mitigate them. Risk is also about balance. I cycle home from work (well, I did in those halcyon days when we left the house) even though I know cyclists are 15 times more likely to die on their journey than car drivers. Side note: cyclists are so well looked after in Denmark that the stats might be different here but I couldn’t find them. But I take into account the health benefits of regular exercise in the fresh air, and I mitigate other risks by wearing a helmet, having lights, and only cycling in bike lanes.
Before investing, it’s good to understand your attitude to risk. Financial advisors have a nifty little questionnaire they use to assess your risk appetite, but you can do a lot of that analysis yourself by using the following questions:
- What can you afford to lose? If the answer is ‘none of it’ then you are going to be looking at some very conservative approaches. This is a good question to help work out a sliding approach to investments, where you safeguard what you absolutely cannot lose in cash or bonds, then portion out other percentages in increasingly high risk investments. There are funds that will do this for you as well: Vanguard’s LifeStrategy funds for example are staggered so as to offer a simple option for people in different phases depending on how close they are to retirement. I also ask myself this question every time I invest, especially in non-traditional areas. When I invested in cryptocurrencies for example, I only put in what I could afford to completely lose. My tolerance is more around ‘potentially losing my ability to go on holiday that year’ rather than ‘potentially losing my house’. Naturally the answer overall will also depend on where you are in life, and relates to question two:
- What are your goals and timings? If you are about to retire and need a guaranteed income, aggressive risk taking is unlikely to be for you. However, I invest my personal pension for example in relatively high risk investments because I can’t take it for another 20 years. If you are likely to need you money at a specific time, such as if you are saving for a house, then you’re less able to accept the risk of a volatile stockmarket. What this means basically is if you have to pull your money out at a particular time, there is a chance that particular time might coincide with a period of poor performance and you would make a loss. If you can wait for your money, you are much more able to tolerate risk.
- What is your own personal risk appetite? I think I’m quite a risk taker. I’ve lived all over the world, sometimes leaving at short notice, with small children in tow. But I definitely find that as a single parent with, as mentioned, no Plan B, I can be somewhat risk averse when it comes to money. So don’t be surprised if you find that you lit-party-girl sense of self isn’t the one holding the purse strings – and let’s be fair, this might not be a bad thing.
But when the markets went into freefall in 2020, what I thought I discovered was that my risk tolerance on paper was much greater than in real life. I’ve reflected on this a lot since then, as I tweak my FIRE plan, and I am not sure that was accurate. Rather, my risk tolerance during my first financial shitstorm, was pretty low. But having lived through it, and seen that what feels irreversible very rarely is, has built another layer of confidence that I don’t think I would have got without the experience. In other words, you gotta be in it to win it.
But its easy to only consider the risk of taking action, rather than the risks of inactivity. As Tim Ferriss says, “Risk is the potential for an irreversible negative outcome”. And that is what can paralyse us in terms of decision making: the idea that the negative outcome is permanent. I remember being about 13 and choosing my GCSE subjects, and feeling for the first time that I was making an irreversible decision which would set the trajectory for A Levels, university, job – basically my whole life until death. I’ve made many, many switches since then, but that feeling of taking a giant pair of scissors and shearing off possible futures, is something which I still get when making big decisions. And since my decisions now impact on my kids, sometimes making decisions can feel impossible.
And sometimes, we can get caught up in fear spirals, and chalk them up as ‘balancing risk’. Tim Ferriss also has a great series of pieces on fear-setting as risk management: taking time to walk through your concerns and really understand ‘what is the worst that can happen’ can give you new insights onto what is holding you back. Every decision has to be a mix of not just financial, but mitigating the risks of living a half life – not FOMO, but really missing out on showing up as your full, amazing self with all the passions and gifts you come with – are real.
I kind of hate the phrase ‘living my best life’ mostly because it sounds so InstaSmug, but I think that’s what risk management really boils down to. Look at all the aspects first, not just the finances, and trust your judgement.
Buying a house is a great example of this. I am in the process of buying a house based on a relatively simple set of calculations about rent vs mortgage+costs. But I am sunk into a total spiral of worry about all the things which could go wrong and, frankly, just what an enormous amount of money it seems. I keep coming back to two things: one is the calculations I made on affordability, stability of my contract etc; the other is the risk of spending another £120,000 on rent which I feel would be better somehow in my portfolio. And again, risk balancing isn’t just the financial – I want to have somewhere I can paint, and plant trees, and feel at home. If the flipside of the risk is that I am responsible for the whole thing then hopefully my research, pre-purchase survey, and emergency fund, will get me through it. Fingers crossed, anyway!
What is your attitude to risk? And how does it impact on your decisions? Look forward to hearing from you!