Most people run from risk and definitely don’t like taking risks with money. It can be scary, stressful, and anxiety-inducing. Not to mention a decision gone bad can lead to losing everything.
As a recovered compulsive gambler that at one point lost all of my savings, I know quite a bit about risk.
And a whole lot about taking risks with money. It’s exciting, but also dangerous.
Despite that, I’ve realized that for most areas of life, risk is often necessary for growth. Risk, like discomfort, can lead you out of your comfort zone and often to a greater reward.
But what kind of risks are there, and how should you handle them? More importantly, what do you need to do to start taking risks with money so you can build wealth? Let’s get right to that.
I’m about to do a deep-dive into taking risks so buckle up.
And assuming I don’t go off on too many tangents, you’ll learn:
- The two types of risk
- Five ways to handle risk
- The risk you NEED to take to build wealth
What is risk?
Simply put, risk is uncertainty about the outcome of a situation. Especially when there’s a chance the outcome can be different than what you hope or expect.
If you’ve ever gambled, you play with a hope that you’ll win, right? Unfortunately, since you can’t guarantee that, it’s “risky”.
If you’ve never gambled, just think of tossing a coin and hoping for heads. Unless you’ve cheated, you can’t guarantee your expected outcome, so there’s risk involved.
There’re two types of risk, and you need to know both.
Back to my gambling example. When you place any type of bet, you know there’s a pretty good chance of losing, but there’s also a chance of winning.
This is called speculative risk and it crops up in various areas of life.
Whether it’s gambling, tossing a coin, placing a bet between friends, or investing in the stock market, you could lose your money but you also might win. Potential for loss or gain.
Personally, I LOVE taking speculative risks when I have thoroughly considered the risk against the potential reward. It’s the dopamine-fueled adrenaline rush for me!
There’s also the other form of risk you are likely taking because well, you are required to. It’s called pure risk.
Pure risk exists when there’s NO chance for gain, only potential loss. As crappy as that sounds, pure risk is what we take every day.
When you get into your car, you are taking a pure risk. There is no “gain” involved, but there IS a chance of accident which could result in a loss of some sort. Hopefully the loss is JUST money, but lives are also on the line.
This is why we carry insurance. Insurance, whether it’s auto, health, home, or any other type exists to address pure risk. So just to review, speculative vs. pure risk. Keep these definitions in mind as you keep reading.
Your best offense against risk is picking the best approach to handle it.
Risk is pretty much a fact of life. You are going to experience it at some point, so you should equip yourself with the knowledge on how to handle it.
There’s five main ways to handle risk, as presented by Garman and Forgue in this super thick textbook about Personal Finance that I own. What I love about these approaches is that we do most of them without realizing it.
- Risk avoidance: A ridiculously easy way to handle risk is to simply avoid it. By not gambling, investing, or stepping into a car, you have avoided the risk.
- Risk retention: Think of this as accepting and retaining some risk. A health insurance deductible is an example of this. If you incur a loss, you retain some of the risk by paying an initial portion before insurance kicks in.
- Loss control: The point here is to reduce loss frequency and severity. There are two relatable examples to think of loss control: home locks and fire alarms. You lock the door to reduce the frequency of theft losses, and you install fire alarms to reduce severity of a potential loss. Well, you SHOULD be doing these things, at least.
- Risk transfer: When you pay someone else to assume risk, that’s transferring it. Homeowners do this by purchasing property insurance.
- Risk reduction: A common way of handling risk is reducing it to acceptable levels. I personally do this on my daily bike rides by wearing a helmet. Any time I get on my bike, there’s pure risk involved. I reduce the severity of loss by protecting my most valuable asset (my brain) with a helmet.
If I’ve done a decent job at explaining Garman and Forgue’s ideas, I’m sure you can relate to most if not all of these approaches in one way or another.
If I’ve done a crappy job, the summary is in the bold sentence that follows.
You are already handling risk in a variety of ways.
When it comes to your life and money, there’s the obvious forms of risk that you already manage. You know, you carry various forms of insurance to essentially mitigate against the chance of loss.
Auto insurance in case of an accident. Health insurance in case of a medical emergency. Home insurance to protect your property. And life insurance to support your family in the event of your passing.
And while I don’t typically do this, there’s all types of insurances you can buy for your phone, laptop, and other prized possessions.
Lots and lots of insurance.
Protecting your assets through risk retention, loss control, risk transfer, and risk reduction makes a lot of sense. But there’s that remaining approach that can stifle your ability to grow wealth: risk avoidance.
Avoiding risk is easy, but can cost you hundreds of thousands in your life.
Risk avoidance, if you recall, is simply not engaging in the activity that could result in loss.
The most common way that people avoid risk is by going super conservative with their investing or not investing at all.
The former might be justified at times, the latter is a mistake.
Most people are completely terrified of the concept of investing. The thought of it keeps millions of Americans on the sidelines while the wealth of the top 10% takes off like a rocket.
If you want to build wealth, you will need to start taking risks with money by investing.
Whether that’s in a business, the stock market, or real estate with the goal of providing future cash flow. You will need to invest.
Investing is scary though, I won’t lie to you. Especially at first.
It can feel like gambling (it’s not-trust me), and will often test your emotions.
Despite the discomfort, keep in mind that investing is a form of speculative risk. Yes, there’s a chance you could lose, but there’s also a chance you could win.
It’s that chance of potential gain that makes investing inherently a better deal than any pure risk you could take where there’s no chance for gain, only loss.
If you look at any financially successful person, they have investments.
Warren Buffett, Oprah Winfrey, LeBron James, Byron Allen, Francoise Bettencourt Meyers, they all have investments. That’s how wealthy people become and stay wealthy.
Yet, trust in investing, especially among millennials is not that high. As of 2018, only 23% of millennials even favored investing when compared to cash.
And well, that hurts my heart. Even more so when I consider the stock market has performed well in recent years and has averaged close to 10% per year for nearly a century.
Millennials are a bit hesitant to invest.
Having a first-row seat to the Great Recession of 2007-2009 probably has a lot to do with that.
The now infamous “financial crisis” tanked the economy, the market, and left many of us scrounging for jobs.
Crappy times indeed, but they didn’t last. The three years following the Great Recession starting in 2009 was one of the best times to own stocks. Those who invested during the down years were handsomely rewarded during the strong recovery that followed.
Sound familiar? It should. 2020 will go down as one of those “best times to invest” stories. Bank on that.
Investing doesn’t have to be scary and you have options.
My first ever investment was 19 shares of a mutual fund purchased in 2005 at the age of 19. Since then, it’s worth 5x times I what I paid for it.
One of my first individual stocks was 1400 shares of an offshore drilling company in 2015. That company went bankrupt and I lost my investment. It’s somewhat of an amusing story, feel free to read about it sometime.
The mutual fund was invested in a collection of companies. The individual stock I purchased was in *one* company. Both were investing, but one approach was WAY riskier (and scarier) than the other.
When investing, you have tons of options. All of which have varied levels of associated risks, and expected returns. The key is to fully understand your own personal tolerance and let that guide your selection so you can sleep at night.
Since I’m not your investment advisor, I am not suggesting you buy mutual funds, individual stocks, index funds, or anything else. But I am recommending you consider taking risks with your money by investing on some level.
If you need assistance getting started, consider talking to an investment advisor.
I learned about the stock market at age 19 from my father and an investment advisor. By working with someone who literally studies the stock market for a living, I was able to pick his brain while he helped guide me to the right investments for me.
Keep in mind that if your employer offers a sponsored 401(k) plan, that IS investing and you should consider getting involved (if not already). Especially considering 41% of millennials have NO retirement savings! ::grabs chest::
Heading into your later years with no financial plan for growth is a risk you literally cannot take. There’s nothing to gain from it, only loss.
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- Financial Stability: Balancing Your Past, Present, and Future
This may sound harsh, but if you are a bit untrustworthy of the stock market, you’ll have to get over it.
Well, if you want to have a comfortable retirement and don’t plan on inheriting millions, that is.
Fact is, saving and sitting on a bunch of cash is safe, yes. But it won’t get you to retirement.
The vast majority of Americans don’t make enough to save enough cash to start, let alone last during retirement. You’ll need to start taking risks with your money by investing.
This is your opportunity to take advantage of compound growth, combat inflation, and start building the life you want.
If you are keeping most of your monetary assets (money) in conservative options like savings accounts, you are taking a risk.
You are taking a risk that your money won’t grow, and it likely won’t.
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