Risk. The Oxford Dictionary defines risk as 'the possibility of something unpleasant or unwelcoming happening'! It is therefore not a word which most of us are that much inclined towards.
Volatility on the other hand is defined as 'liability to change rapidly and unpredictably, especially for the worse'. Volatility is different to risk, it's subtle but it is different. It more-so relates to the potential degree of ups and downs in a fund or investment portfolio. We will get to volatility another time!
Many of us will recognise when it comes to investments that risk is an unavoidable element in reaching an investors objectives. But there are many other forms of risk which many of us don't really think of until it happens! In this episode we will unearth these risks, and indeed share ideas on what one can do to manage them (if possible!).
On a related but separate note we are delighted to tell you that we have written & launched our first ever quick-guide resource for you guys!
This was based on your feedback to our Financial Planning in Ireland Survey a few short months ago. We want you to download your own complimentary copy of the '4 Principles Guide' to Investment Success; simply click the pop-up or head over here and add your email, we'll mail it directly to you, for keeps, at no charge at all........limited time offer!
I'm not about to tell you that risk is a great thing and should be embraced at all opportunity, and nor am I going to tell you that you should avoid risk at all costs, and that's for a few reasons.
a) There are lots of different types of risk when it comes to Financial Planning (more on this in a minute!)
b) Each of us have our own varying appetite and capacity to take risks (more on this also!)
c) A lot of us might not need to take risks with regards to aspects of our finance. If for instance you already have enough money (or will have if you follow your plan) to provide you with the life-style you want who would you take unnecessary risks to try and get more!?
d) Some risk we can't control, they are the same for pretty much all of us (bare with me!)
So, what are the different types of risks in the area of Financial Planning, and how might they impact me?
If one was to dig deep enough there are over 100 types of risk (some of them I'm sure are just made up!) but in reality the following 6 are the main ones which us millennials face as we steer a course through our financial lives.
1. Ostrich Risk:
OK, so I've made this one up!! Having said that this can be one of the single biggest risks, and it can be classed as the assumption that whatever way we are set up, whatever plans we have or have not got in place, that we don't investigate them and that we assume they are fine! They may be but unless we check then why have them in the first place!
Solution? Educate yourself, find out what you have and have not got, determine how near of far you are from your goals. You can then decide whether further action is needed.
2. Market Risk:
The risk of investments/pension funds declining in value due to economic circumstances. For instance we say typical investment fund/pension funds fall by 40% in 2008. If you had all your money invested in the Irish Stock Exchange your fund would have fallen by 90% that year! Yikes! This proves that while there are risks associated with investing that the 'markets' are volatile, and so your investment portfolio may also be. These types of market draw-downs (as they are known!) have happened before and will happen again to some degree or another.
Solution? To the best of our knowledge individual investors/pension holders can't control the markets however we can control what markets/assets we invest in! Check out this podcast to find out how that can be done to manage the risks of your investment portfolio. As above, do you need to take risk and enter volatile waters? What is your objective? Do you really need that? Answering these will help identify the way.
3. Mortality & Morbidity Risk:
The risk of you dying or becoming ill. It is a risk we all face, indeed reading a book recently recommended by a Fund Manager (Will, we will have you on soon!) called 'The Obstacle is The Way', goes to lengths to remind us of our mortality.....and claims that it is only then will be become truly grateful for the lessons life throws at us while we are alive.....food for thought!
Anyway, if you die it's probably fair to say it will have an impact on your finances and those of your family. Likewise of you are ill or indeed seriously ill for a period of time it may well impact on you and your family's ability to manage financially.
Solution? Have a Plan B! You can do this through having appropriate life cover, income protection, specified illness cover policies which will support you in any of these events (check out , this, this and this). Alternatively you may have sufficient assets which would be utilised to replace lost income.
4. Longevity Risk:
My personal favourite although it's no less difficult than most of the others. This is whereby one would outlive their money! We are all about Financial Planning for millennials in Ireland here so lets take pensions for instance. Lets say you retire tomorrow with what you consider to be a decent pension pot and you start to draw it down, you are age 68. You assume it will do you until you pass away, and you assume that will be 20 years from now, age 88. What happens if you live to 100!? Your pension pot could be gone and you have 12 years of life to live!
Solution? Plan effectively. Stephen Browne of Voyant ( A Cash Flow Modelling Tool- sexy stuff worth checking out!) uses the assumption that we will reach age 100 when creating financial plans through their soft-ware. Worth considering when it comes time for you to prepare your income in retirement. One way of ensuring you don't outlive your money is to make sure you die 'on time'! Not suggesting any of us want to plan to do that either!
5. Inflation Risk:
Simply this is the risk of a loss in your purchasing power because the value of your investments/pensions do not keep up with inflation. Why? Well inflation erodes the purchasing power of money over time – the same amount of money will buy fewer goods and services. Inflation risk is particularly relevant if you own cash deposits, as they more often than not do not return the rate of inflation.
Solution? If one has the appetite then one could aim to beat inflation by allocating some of their cash deposits toward other asset classes. This is particularly evident in today's environment where we see deposit rates at long term low levels, people are looking for more and to avoid inflation ( Inflation in Ireland as of March 17 was 0.7% and deposits are in region of 0.3% Net!).
6. Liquidity Risk:
We have heard it in the movies, 'I'd love to help dude but all my money is tied up at the moment'! While this may have been a line trotted out to decline a loan to a family member it can also be a thing which impacts on investors. Imagine you had invested heavily in property in 2006, as an investor. You invested 200k into a Commercial Property Fund because it was going so well and you wanted a piece of the action. A few years later its 2010 and you needed to get your money because you were retiring and needed it to replace income. You would have been lucky to get back 100k if you had been able to sell out at that time. No thanks! A basic example but one which nonetheless portrays the risk associated with having your investment portfolio 'tied up'.
Solution? Have a clear plan, consider all eventualities and needs for funds, and build your investment portfolio around that. Many Retail Property Funds carried a particular liquidity risk which resulted in investors not being allowed to cash in their investments until they had served 6 months notice. While this may seem deeply unethical/unfair it can serve as a safety valve to protect all investors (and indeed the manager) in this type of product. Key thing as always is to know what you are doing and be prepared. Don't be the ostrich!
So there you have it........6 of the main risks in managing our Financial Planning and goals. None of these are that scary, until of course you are faced with one, and at which point we ask ourselves 'why didn't I prepare for this!!'.
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