Risk Management: Mitigation or Acceptance
One of the riskiest behaviors I engage in is motorcycling. I have owned five motorcycles in my lifetime. My first was for commuting. My final is for pleasure. Although I greatly enjoy riding, I doubt I will buy another. At some point, my ability to ride will deteriorate to the point where is just simply too risky.
I recognize there is risk to riding a bike, so I engage in a variety of mitigation efforts. First and foremost, I always wear full protective gear. This includes a full-face helmet, boots, protective gloves and pants and jacket with protective inserts. While this may protect me from a tumble and subsequent slide, it may not do much in a collision with a vehicle.
To further mitigate the risk, I tend to ride on weekends earlier in the day when there is less traffic. I also avoid riding in the rain and going unnecessarily fast. Finally, I am hyper vigilant when I am on a bike and give wide berth to other vehicles. I believe the sum total of these efforts allow me to safely practice a fun hobby.
Risk management should also be applied to both financial planning and investing. In financial planning, risk management is critical to successfully achieving your goals. One critical mitigation step is determining insurance needs or gaps and solving for it. For example, the main bread winner in a household should plan for the scenario of loss of job, disability or even death.
Term life insurance is a great, inexpensive means to mitigate the risk of death and its impact to surviving family members. A healthy 40-year-old male can get a $1,000,000 20-year Term Life for as little as $30 a month. This provides great peace of mind for the entire family.
Other insurance products like Whole Life, Universal Life, Variable Universal, etc. can also be useful in the right circumstances, but these can be complex and confusing while not providing the benefits sought. Oftentimes, investing in the market in combination with Term Life will be the best solution for many situations.
One of the biggest concerns in retirement is the need for a steady income stream. Annuities, Fixed or Variable, may be an important solution to evaluate. These products are also complex and can have high fees associated with them. On the flip side, they can almost eliminate the risk of loss of income in retirement. It is important to due significant due diligence. In most cases, you should not convert all of your portfolio into an annuity, only a portion of it.
If healthy, it is better to take this on later in life. For example, a person who invests $250,000 in an income annuity at age 65 when the interest rate is 2.5% and life expectancy is 15 years, the monthly annuity payout would be $1,663.66. If they wait five more years to annuitize, the monthly payout amount rises to $2,353.54. Wait until age 75, and it becomes $4,433.75 for life.
Developing additional skills or certifications can mitigate the risk of job loss. If you do not take these steps then you are accepting the risk.
In investing, a key component to risk mitigation is portfolio diversification. The risk of a $100,000 portfolio invested in one stock is dramatically higher than a portfolio invested in variety of ETFs across all asset classes. Now the performance return of the diversified portfolio may lag the performance of a single “hot” stock, it does mitigate the risk in betting it all on the performance on one equity. Buying one stock is not investing, it is gambling. You may win sometimes, but there is a reason casinos generate big profits. The odds are always in their favor.
If you want to discuss risk management and the benefits of a diversified portfolio, please contact me or visit my website: www.fiduciamwealth.com
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