Risk Aversion and Solutions
December 10, 2008 – 4:41 amOne way to face risks in life is to consider the worst possible outcome and then be willing to accept that outcome. If you can accept the worst possible outcome then there is no reason to worry or fear. I prefer to take this exercise one step further and identify things I can do to mitigate some or all of the “bad” outcome. If you really want to be a superstar write down those things that you identify.
I love using this technique when making decisions. Investing decisions, career choice decisions, and even smaller decisions like whether or not to repair my automobile. This kind of mental exercise can be very valuable if you are mildly or very risk averse.
Let’s take investing as an example. What’s the worst thing that can happen if I invest my money? I could lose it all. Then what? I’d feel like a failure. Then what? I’d lose all of your friends because they’d think I’m a loser. Or my family would be made at me? Then what?
Well, let’s see. I suppose I would still go to work the next day. I would be back right where I started a few years ago when I paid my last debt and was finally able to start saving and investing. I’d still be better off than others who are still working their way out of debt.
What are some other ways I could limit the risk of losing all of your invested money? I could:
- invest more conservatively
- learn more about investing before I get started
- use a financial adviser
- invest my initial funds very conservatively, and then use the earnings and interest to invest more aggressively. I’ve though about doing this at times. Let’s say you have $10,000 saved and want to invest it. If you put it in treasury bonds you could then take the interest and invest it in a stock market index fund. Although it’s a form a mental accounting, if you did this you may find that you “feel” like you’ve never lost money, because even if your stocks go down your initial capital ($10,000) is still safe and secured and is still producing money that can be invested more aggressively.
- I could fund an emergency fund that would allow me to invest and potentially lose the other money I have available without fear of needing the invested money in the short term. I could also double or triple my emergency fund if that makes me feel more comfortable.
- I could invest in a variety of products that have guaranteed rates of return. The returns may be lower than more risky investments but they may be right for me. CD’s, money market funds, some forms of annuities, etc. might meet my needs for some or all of my portfolio.
Some risks are real, and others just seem real to us. There are always ways to reduce risk. A little creativity, combined with a little knowlege about yourself and how you operate is all you need to move past your fears and take a step forward.
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4 Responses to “Risk Aversion and Solutions”
Other risk control options including insuring against other financial risks that you might have used your now-depleted invested funds for. This could include disability insurance and long-term care insurance. Also, securing essential services (shelter services, transportation services) without needing income to pay for them lowers your risk.
By Mr. ToughMoneyLove on Dec 10, 2008