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Understanding Risk

October 14, 2014

Many people are concerned about risk, but don’t really understand it.  Risk is ubiquitous – it is always there.  There just are different types or forms of risk.

Risk is also unknown because it is a gauge of something that will happen in the future.  What you need to do is make your decisions based on what you know, what you might be able to control and your expectations of the future and then hope for the best.  This does not mean you should ignore what has happened in the past because it is a guide – or a warning – of what can occur in the future.

Another thing to consider is not only how secure you will be in the future, but also how secure you will feel. You can be fully secure but not know or recognize it and feel insecure.  “Secure” means that you strongly feel you will not outlive your assets after withdrawing sufficient amounts to live your life the way you want.

If you need more than what you presently have to feel secure, then pick a targeted amount at a given time and set a plan to reach it.  If your plan is attainable, good for you.  If not, then you might need to change your goals or current or planned spending.  But, at some point, you will either be there or you won’t.  That is how you will determine whether you feel secure.

Risk will always be there and just because you are uncomfortable or insecure about certain forms of risk doesn’t mean you are making the right investment decisions bypassing them.  In my opinion, it does mean (in most cases) a lack of knowledge about investing and a lack of understanding about those types of risk.  Risk cannot be avoided.  It can be reduced, transferred, accepted, decreased or increased, but it cannot be avoided.  One simple illustration is the prevalence of inflation.  You accumulate an asset base to provide cash flow to be spent.  If your earnings are lower than the inflation rate, over any reasonable period of time, your asset base will eventually be reduced.  Right now, short term Treasury Bills, perhaps the most risk-free investment in the world is yielding less than 10% of the inflation rate.  One year insured bank CDs are paying less than 25% of the inflation rate.  Things may change, but they may not, and if they don’t, you will run out of money unless you have a humongous amount where this is not a concern.  This is not the case for more than 99% of the people in the United States.  Investing risk-free can possibly drive you into the poor house.

A second illustration is to assume that investing “risk free” will not permit you to attain the degree of security you need, but undertaking a measured risk such as investing in the same items but for longer terms providing higher yields might.

Risk needs to be considered, but measured against realistic priorities.

One Comment leave one →
  1. 6hawthorne permalink
    October 14, 2014 1:43 pm


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