Financial Risk: Do You Really Understand It?

Risk

Risk, risk/reward ratio-we  think we know what risk is.

We hear about risk all the time-sometimes in oblique ways-”That  BB gun will put someone’s eye out!!” as Ralphie heard over and over in A Christmas Story.

Don’t drive too fast, wear your seat belt, don’t swim on a full stomach, are all common comments.  And these days, more and more are concerned about the risk of the stock market!

Your Biggest Risk-May Be Income Related-Not Stock Market Related!

There is an interesting article in the WSJ about Thinking Smarter About Risk by Professor Moshe Milevsky. He suggests thinking about what would happen to your earnings or paycheck if the stock market crashed 25 or even 50%.

He gives a good explanation of the term-Beta.  Beta, in stock market parlance, is the risk of a stock-as compared to the market as  a whole-if the stock has twice the market risk-then it has a Beta of 2.

If it has the same risk as the market then the Beta is 1, and if the stock has no correlation to the stock market-then the Beta is zero!  He points out that our jobs also have a Beta-our future income may be correlated to the stock market, or completely uncorrelated.

Most nurses would see very little change in their earnings capacity-with a stock drop-so their Beta may be closer to zero.  Their earnings risk may be tied to the health care bill, but not really the financial markets.

(Maybe we should come up with a risk variable on how our incomes are tied to congress and new laws and regulations-Alpha and Omega risk ratio, perhaps!)

But most in the financial world-bankers, brokers, and brokerages, and thousands of their support staff would be devastated by another severe, prolonged market correction. Not just in their investments, but the job itself, and it’s lifetime of  income!

Dr Milevsky’s point is that our financial risk is many times much more correlated to our career earnings and income, rather than our investments.   And we need to adjust our thinking to account for that risk.

What does this personal financial risk mean to you and me?

• Keep an eye out for changes in the industry you are working  that may effect your future income.  If you are working in the insurance, medical device, or pharmaceutical industry-your risk of your companies’ financial health deteriorating may be increasing-so make adjustments in your savings-to be prepared for further layoffs or income shifts.
• If you are working for a hospital, whose profits are being squeezed by decreased reimbursements-realize much deserved raises may just be a dream so adjust your spending-or find other ways to increase your income-or both.
• If you are  at your pinnacle of pay-reached the glass ceiling-and are comfortable with that-you have savings built up-then you can take more risks with your investments-than someone just starting out.  Standard thinking is that as you get older, you decrease your risky investments-it may be time to consider increasing the risk slightly-as you can deal with the downside more.
• Insurance-life and long-term disability insurance helps to decrease your income risk-for you and your family.  So insure your human capital!
• Make sure your education investment risk-the huge amount of money and time required for your degree-is protected by a likely chance you can repay that investment.  (Don’t borrow tons of money-for a career with no possible chance of bringing in the income required to pay for the education!)

Financial Risk:

Think it over.  Do you have income or job risk, that you are not taking into account right now-if so, make adjustments.  Change your investments to something more conservative and liquid.

Think about what your steps would be if you lost your job or had a decrease in pay.

Don’t be caught  with your scrubs down around your knees.  Don’t spend  all your time worried about your investments-and not enough concern about your primary money factory:

YOU AND YOUR JOB!

Reader questions:  What are your thoughts about risk?  Do you think we balance our job risk and investment risks appropriately?

Tags: income risk, job and income risk, mitigating financial risk, risk, risk/reward

This entry was posted on Tuesday, June 15th, 2010 at 6:43 am and is filed under Retirement savings, Wealth building. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.