Financial Risk Management for 2020

Posted 4 years ago

by merge

A bright businesswoman I know once told me that the reason she doesn’t invest in the same opportunities I do is because she’s conservative. In reality, I’d argue that she’s not conservative —she’s uneducated.

Which brings me to the question the financial planners should be asking: Are you educated or uneducated when it comes to your investments?

Saying you are “conservative” is just a risk management excuse that could easily be translated to, “I’m uneducated, scared, don’t know what to do, and don’t want to take the time to learn.”

Think about it: If you tell your financial planners you are a conservative investor, they know right away that you are uneducated about investments. This gives them the opportunity to pray on your weakness and sell you whatever they want!

And as dumb as that sounds, thousands of uneducated “investors” hand their money over to financial planners every year. According to a 2012 article in the Wall Street Journal, “the National Association of Personal Financial Advisors, a group of about 2,100 advisers … has doubled in the past seven years as more and more individual investors seek professional guidance.”

And here’s a more recent stat that should scare you as much as it scares me: The total assets under robo management — that means a computer is using automated algorithms to build and manage a client’s investment portfolio instead of a living, breathing human who calls themselves an expert in this field — grew 15% in 2018 to $257 billion. And it could top $1 trillion by 2023. Technology is rapidly changing the financial advisor space, and not necessarily in a good way.

You see, the conventional wisdom of most financial planners is: “The higher the return, the higher the risk.” But that’s not really true. I’ll tell you what is true: The lower your financial intelligence, the higher your risk; and the higher your financial intelligence, the lower the risk. And that’s why it’s crucial to improve your financial intelligence — it’s the only way to truly learn how to reduce investment risk.

Another way to assess investment risk

So many people mistakenly think that investing is risky, when in reality it’s the investor who is risky. Think about it: An investment is just an investment, whether it’s a business, a property, a stock share, or a commodity. It’s you, the investor, who determines if a specific investment is a good or bad investment for you.

If you’re wondering how to reduce investment risk, start by knowing this: Not every investment you choose will be a good investment, as no investor has a 100% track record of picking winners. Yet, the more knowledge you have, the better your odds for reducing investment risk.

Plus, if you have done your research, you will know why you are making a particular investment and what is happening with the money you invest. If you just turn your money over to a financial planner to invest for you, you lose control, and when you lose control, your risk factor goes up significantly.

Here’s another way to examine this theory: I a car going 25 miles per hour driven by an experienced driver risky? Probably not. Take the same car and the same speed driven by a drunk driver and that same car becomes a weapon. It’s not the car; it’s the driver. It’s not the investment; it’s the investor.

As you might imagine, my own risk tolerance is pretty low. I don’t like taking risks with my money. And neither does Robert. Nor do our close investor friends. We study, we research, we build up our experience.

Have I taken risks? Yes, I’ve invested in stocks I knew virtually nothing about. I’ve stupidly turned my money over to a money manager and blindly followed his recommendations. Heck, I’ve even invested in a hedge-fund deal that I suspected was too good to be true. And guess what? It was.

The good news from these embarrassing and financially difficult experiences is that I learned from my mistakes and will never invest in anything I don’t fully understand again.

During risk analysis, beware of ‘guarantees’

My friend, Karen, called and told me about an investment she was considering. She was going to invest $50,000, which was pretty much all the money she had saved over the years.

Karen explained to me over the phone, “I’ve been reading several financial books and have attended a couple investment seminars. But I’ve been very nervous about actually investing my money. My solution has been to keep studying. I’m thinking that as long as I’m studying, I’m in the investment world. I just cannot pull the trigger. I am still single and just don’t feel I know enough about finance.”

She went on to say, “My two friends in California called me a few days ago, and they are all excited about this new investment they just got into. They told me that I’m guaranteed to get 100 percent of my money back with in the first six months. They said their friends are in it, and a few celebrities too. And that I need to decide quickly, because it is only available until the end of the week.”

The word “guaranteed” was a huge red flag for me, as was “get 100 percent of my money back within the first six months.” It definitely sounded like a deal that was too good to be true.

I asked Karen, “What specifically are these people investing in, and how can they guarantee that return?” I was trying to help her do a risk assessment.

She told me she didn’t know, but would find out. I pleaded with her not to go forward until she had the answers to those basic questions that could help reduce investment risk. I also didn’t like the pressure put on her to make a big decision so quickly.

At the end of the week, Karen called to said she was not going through with the investment. I felt relieved and suggested some other possible investments for her to research.

Fast forward five months: I received an email from Karen that said, “After I told my friends I wasn’t going to invest, they came back a week later and said, ‘You’re so lucky. You have another chance. They have extended the deadline for one more week, so you can still get in on this deal. We really think you should do it.’ The peer pressure got to me, so I invested my $50,000. Today, five months later, my money is gone. It was all a scam. I lost it all.”

I must admit, I had no pity or compassion for Karen. I was astonished, and even angry with her. She knew better! She let her emotions and personal friendships take over the rational part of her brain. She also didn’t do what she knew she had to do to properly conduct a risk assessment of this opportunity. She so badly wanted it to be true that she put her good judgement aside and rolled the dice.

The moral of this story is: With little or no financial know-how, a deal that sounds too good to be true … is! That’s one clear way to reduce investment risk. The lower your financial education, the higher your risk.

Redefining what risk means

Warren Buffett says of risk, “Risk is not knowing what you are doing.” Again, the key word here is “you,” not the investment.

Over the years, I’ve come to define RISK as:

Reckless
Investing
Sans
Knowledge

My friend and stockbroker, Tom Weissenborn, offers these two rules when it comes to investing in stocks:

  1. If you don’t understand how the company makes money, don’t invest in it.

  2. If it looks too good to be true, then it probably is. Just like my own folly once upon a time, Karen learned this particular lesson the hard way.

As you’ve learned, in the world of investing, there are no investments that are 100% guaranteed to be safe (free from losses), but there are things you can do to reduce investment risk and increase your chances of success:

  • Give yourself a financial education

  • Gain hands-on experience by actively investing (a small amount of) your money

  • Understand the investment and the return on the investment

  • Have control over your investments

  • Become your own financial advisor

Part of your financial education should include reading my book, It’s Rising Time. In chapter 16, you’ll learn more about how to conduct a risk analysis, with a focus on ROI (return on investment). It’s how you calculate how much money you will make on an investment, and a crucial piece of information when evaluating investment opportunities.

If investing sounds like something you’d like to explore, then do everything in your power to educate yourself about every deal you consider — it’s the only surefire way to reduce your investment risk and increase your odds for success

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