Risk is part of life’s fundamental reality. Strangely few people know about it in a way that allows them to think constructively.
The aspects that are useful include:
- Risk Exposure. If you own a business, or are an oil-well firefighter, you will get the idea that your risk of continued life and solvency are not the same as those for a civil servant. Risk exposure is an easily overlooked aspect. Diversity of investment deals with the business owner part. Insurance, when available, helps too.
- Risk Capacity. Bill Gates probably chooses a higher deductible on his casualty insurance to reduce premiums and because he can afford a bigger loss before he wants someone else to pay. He may even self insure. Each of us should decide capacity before we enter into any arrangement of insurance or investment. Question 1, is “How much can I afford to lose?”, Question 2 is, “How much can I make by accepting some of the risk?”
- Risk Tolerance. People with little experience tend to be either more highly tolerant than those with experience or afraid of everything. Experience has value in that it can teach ways to identify, to avoid and to manage risk. People with knowledge and experience do not fear things that novices might nor do they overlook problems. Tolerance is usually a function of staying inside the limits of your capacity and exposure.
- Risk Management and Mitigation. It is difficult to manage risks you don’t know about using tools you misunderstand. Police, soldiers and athletes know about protective gear. Zookeepers notice subtle behaviour. We know that “hold my beer, I want to try something” usually ends badly.
There are simplifying ideas to manage risk.
- A decision you can reverse at an affordable price is not risky. Possibly inconvenient.
- A situation where you can identify the risk earlier than others is low risk. The judicious panic rule. “If you must panic; panic first”
- Risk management is seldom an event and is usually a process. File backup, locked doors, no smoking in critical areas.
- A monetary risk you can insure is just an expense.
Investment advisors have risk. There is no clear process to manage it and their errors and omissions insurance may not save them. They are required to assess their client’s risk profile and to date, there is little help in the way of doing so. My experience is that everyone has an aggressive approach to investment risk up to the point where they lose money. Then they are conservative. That approach is not helpful.
By way of solution, PlanPlus, a financial planning software provider and designer, has been tasked to find a better approach. I have known the founders and some of their key people for decades. I know they will be thorough and helpful in addressing this question. A recent articles at Kitces makes the point.
The Sorry State Of Risk Tolerance Questionnaires For Financial Advisors
If you perform perfunctory “Know Your Client” assessments, you own the risk. Probably a material risk. You might want to deal with that. It won’t go away on its own and regulators are beginning to care more than they once did.
Start with an easy step, check out PlanPlus.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. email@example.com 866-285-7772