Managing Personal Finance Risk

Dear “Not Sure What To Think About Risk”, Today, I am writing to you about managing personal finance risk. When you invest, there is risk. As you are pretty young, you may not have thought much about the topic. But if you are going to be an investor, you need to think about managing risk because all investments involve some degree of risk.  

So, to make sure that we are on the same page, let me start by defining what I mean by risk. 

What is “risk”?

Risk is anything that involves the possibility of danger. 

Today, I am focusing on personal finance risk.  

What Is Personal Finance Risk?

So, as I said, risk in general is related to danger. In general personal finance risk involves uncertainty that may have a negative impact on your finances. In short, there is the danger of losing your money. 

There are multiple types of personal finance risks. But, I am not trying to make this a full finance course here. So, this is not meant to be a comprehensive list. These are some of the ones that I think about most when planning my personal finances. Let’s get started.

What Are Some Types of Personal Finance Risk That I Think About and How Am I Managing Personal Finance Risk?

Employment Risk

Employment risks exist because people can have a reduction in the number of hours in their job, or even worse, you can lose your job. 

Managing Personal Finance Risk: What do I do to protect myself against employment risk? 

• I have an emergency fund.
• In addition to my regular job, I often have a side hustle. 
• I create multiple streams of income, some of which don’t require ongoing work. 

Inflation Risk

Inflation risk exists because your purchasing power tends to decrease over time. In fact, in some times, it decreases at a faster rate than other times. When your purchasing power decreases, you get less for the same amount of money. 

Managing Personal Finance Risk: What do I do to protect against inflation risk?

• Though I may have had an initial target size for my emergency fund, like enough money to cover one year of expenses, I continually add money to my emergency to reflect the fact that due to inflation, one year of expenses is always going up. 
• At the same time that I maintain an emergency fund, I don’t let it grow any larger than it’s target size. This is because, during inflationary time, the cash cannot keep up with inflation. 
• I purchase government bonds called TIPS – Treasury Inflation Protected Securities, which are designed to protect the principal that you receive at maturity from ever going below the amount that you invest. Instead, due to inflation over the holding period, your inflation adjusted principal could be more. Because federal tax must be paid on the increase in the value of principal annually, I feel it is best to purchase these in a tax-protected account. (I feel that the best would be a Roth IRA, since the income in those accounts will never be taxed.)

Interest Rate Risk

Interest risk exists because when you lock in an interest rate, future interest rates may go up. When future interest rates go up, the value of the principal of the instrument (like a CD or bond) that you have locked up at the lower interest rate goes down. So, when we lock in an interest rate, it is a risk.  

Managing Personal Finance Risk: What do I do to protect against interest risk?

• I include some investment in bonds and certificates, which have short-term maturity. These securities with short maturity tenure are less susceptible to fluctuations in interest rates.

Liquidity Risk

Liquidity risk is when you can’t access your money quickly enough. For instance, if the opportunity to buy an asset came up, and you had a maximum of seven days to do so, but you could not access your cash quickly enough because all of your net worth was in real estate, you would likely risk losing the opportunity to purchase the asset. Some examples of illiquid assets include real estate, works of art, antiques, collectibles, cars, and private interest in business. 

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Managing Personal Finance Risk: What do I do to protect against liquidity risk? 

• Because I keep an emergency fund, I rely on it as my cash reserve when necessary. But, I only do this when I am confident that I can replenish it in a timely manner. Also, I never take out more than one third of my emergency fund to use for a non-emergency. Most importantly, I would never borrow from my emergency fund to purchase anything other than a cash-flowing asset.
• I purchase assets with varying degrees of liquidity. For instance, stocks are more liquid than bonds. Bonds are more liquid than rental properties. 

Health Risk

Health issues suck. But, they suck even more if you can’t afford to access the goods and services needed to combat the health issue. Furthermore, health issues can temporarily or even permanently interrupt your active income. Because of that, health risk can also be a personal finance risk.  

Managing Personal Finance Risk: What do I do to protect against health risk? 

• I try to take care of my health.
• I always have health insurance. 
• I am building streams of income that can continue if I am out of work due to health (or any other reason). 

Stock Market Crash Risk

A stock market crash is a steep and sudden drop in stock prices.  While I think that it is very important to be invested in the stock market, I know that there is always the risk of a stock market crash. 

Managing Personal Finance Risk: What do I do to protect against stock market crash risk? 

• I don’t invest more than I can afford to lose.
• I diversify my investments. This means that I also invest in things that do not correlate to the stock market. For example, I invest in real estate. 
• Within my portfolio of equities, I include REITs. REITs are said to be generally less volatile than the S&P 500. 
• Ultimately my goal is to not only be able to survive a stock market crash by turning to my other income streams, but to also have some cash set aside to be able to buy deeply discounted stock during a crash. 

Longevity Risk

Longevity risk is the risk of reaching an age at which you do not have enough money to fund your life. 

Managing Personal Finance Risk: What do I do to protect against longevity risk? 

• Because I know that there is a chance that I could live a long time, I buy some assets that should be able to pay me for a long time into the future, such as, when I like the interest rate, 30 year Treasury Bonds.
• I buy assets that should be able to last beyond me, such as rental properties.
• I buy long term care insurance. 
• I buy and create streams of passive income that can continue to pay me indefinitely. 

Managing Personal Finance Risks: Key Takeaways

1. Risk is anything that involves the possibility of danger. 
2. Personal finance risk involves uncertainty that may have a negative impact on your finances.
3. There are many types of personal finance risks.  
4. Some examples of personal finance risks include:

• Employment Risks – which can range from less employment to no employment.
• Inflation Risks – which means that your purchasing power can decrease.
• Interest Rate Risk – which exist because newer interest rates may be higher than the rate that you have locked in in an investment. 
• Liquidity Risk – when you can’t access your money quickly enough when you need it.
• Health risks – which can require you to spend more money while simultaneously preventing you from earning more money.
• Stock Market Crash Risk – which is when there is a steep and sudden drop in stock prices.
• Longevity Risk – which is the risk of reaching an age at which you do not have enough money to fund your life.

5. Some ways to manage personal finance risk: 

• Have an emergency fund.
• Have some cash held in reserve, for investment opportunities. 
• Have a side hustle.
• Have multiple streams of income.
• Buy Treasury Inflation Protected Securities (TIPS).
• Include interest investments with various terms of maturity.
• Purchase assets with varying degrees of liquidity.
• Include Investments that do not correlate to the stock market, such as physical real estate and REITS.
• Build streams of income that can continue while not employed.
• Try to be healthy.
• Have health insurance.
• Build streams of income that can continue while not employed.
• Buy long-term care insurance. 

There you have it…Some of the personal finance risks that I consider when I am planning, and what I do in order to try to manage them. 

I hope that you found this information helpful. My hope is that it gets you thinking about risks that may exist in your personal finance situation, and perhaps apply some of the methods of managing them when and where you can. 

(But, remember, personal finance is personal. So, investment advice cannot be specific enough for a broad audience. So, of course, talk to your financial adviser first before applying anything you hear or read online. I want you to be safe.) 

Don’t delay, in at least some small way, make your life better than yesterday.

You can do it! I have faith in you. 

Hugs, 

Rich Mom

Here is a link to a good “interest rate risk” video that I found on YouTube”

Interest Rate Risk

Looking to read more about personal finance? You can check out these posts: 

Ingredients of Building Wealth

Three Reasons You Should Learn To Do Taxes

10 Things That Everyone Under Age 30 Should Know About Taxes

Building Wealth In Your Twenties

Having Fun While Building Your Wealth