Risk in the actuarial sense says, how much is the loss or cost to repair something, and how likely is it to occur?
Investment risk (measured by variability) is a different animal entirely. Variability is not risk in the sense that you have lost something. It requires a transaction to crystalize the loss and if you don’t have to have the money right then, nothing changes. Liquidity is the defense.
The actuarial results are different from investment risk in an important way. Actuarial risks tend to happen or not, while variability is a continuous factor in a particular marketplace.
Actuarial risk is measured by the amount and the risk of it occurring within a given time span. If a house would cost $500,000 to replace and its probability of being destroyed in the next 12 months is one in a thousand, the actuary will value the loss at $500. You and the actuary come from a different place. Because you could afford the $500 loss does not mean you should accept it. Your house cannot be 0.1% destroyed. You are in an all or nothing world. Actuaries deal with averages.
The process is fairly straightforward and is aimed at what action you should take. It involves anticipating, always a useful way to manage the future.
The management process begins with estimating the problem:
Investment risk is not a risk except if you stop participating. Variability works both ways and eventually dies down. The average of all the noise is zero. If there is a risk of real loss, like the company goes bankrupt or you need the money now, you need to use the actuarial like methods.
Actuarial, averaged risk methods are great for insurers, but not relevant for you. You cannot be partly alive and partly dead. You must assess your risk as if you are 100% dead and go from there. Most people deal with low probability events poorly because the see the probability and not the effect of the loss.
If you pay the premiums and have no claim, you lose the premiums. If you don’t pay the premiums you have a small gain, but if you have a claim, your beneficiaries will be poor. Pick the form of poverty that is most affordable and make an adult decision.
I help business owners, professionals, and others understand and manage risk and other financial issues. To help them achieve their goals, I use tax efficiencies and design advantages to acquire more efficient income and larger, more liquid estates.
In previous careers, I have 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.
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