Financial Risk Management.
Posted on | January 6, 2008 |
“Misfortune loves a shining mark…. Every owner of gold is tempted by opportunities whereby it would seem that he could make large sums by its investment in most plausible projects.”
-Arkad, the Richest Man in Babylon.
Translation: Don’t take unnecessary financial risk or make foolish choices with your money.
This is the 4th of the 7 cures for a lean purse as detailed in George S. Clason’s The Richest Man in Babylon.
So what is “unnecessary risk”? What does “safety” really mean in regards to money? This section of the book stresses one of the “Sound principals of investment”. Namely: Security for thy principal - don’t put your principal at risk. This strikes me as too conservative in a general sense, so I would say:
“Don’t put your principal at risk for the possibility of astronomical (unreal) gains.”
I make this point because anyone who invests in the stock market, bonds, real estate or even a money market account is putting their principal at risk to some varying degree. A stock can become worthless. Bonds and real estate can lose value and you can be left owing more than you put in, and money markets can fold. I think a money market has only lost value 1 or 2 times in the past, so it’s a small risk to be sure, but a risk nonetheless.
That being said, I think it’s bang on regarding your emergency savings. That principal should not be put at risk. Stow it in a high yield savings account or bank CDs, both of which are FDIC insured.
“Study carefully before parting with thy treasure.”
Don’t invest your money in the latest fad, just because your friends or relatives tried to sell you on it at the weekend picnic. Do your research and due diligence and know what you’re investing in. What are the risks? Are there certain economic conditions that will favor the investment? Is there a business cycle to consider? Seek professional help or knowledge if needed. Or learn about index investing and diversify into the entire stock market.
“Be not mislead by thy own romantic desires to make wealth rapidly. Be not too confident of thine own wisdom. Consult the wisdom of those experienced in handling money for profit.”
If at first you have success, don’t get cocky! Arrogance will lead to financial ruin in a heartbeat if left unchecked. Bulls make money. Bears make money. Pigs get slaughtered.
In short, it’s OK to “play the market”, just don’t do it with your savings - use discretionary income.
In conclusion, proper risk management requires a financial risk assessment to find out how much risk you can handle. You either need to educate yourself about managing financial risk, find an expert whom you trust to do it for you, or put your portfolio on autopilot and become a passive investor using total stock market index funds.
Resources:
General information on CDs (rates, how to ladder CDs, calculators, etc…)
Introduction to Index Investing
Title image © by Daniel Fahre
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