You keep using that word
Risk is an interesting word, especially in the personal finance domain.
There are different kinds of risks, and they change according to circumstances.
It’s easy to make assumptions about risk, or to think that one person’s risks are the same as another’s.
For me the highlighted bits are interesting. Risk is about probability, and it involves financial loss.
So how should we think about risk in personal finance?
I guess a huge risk is not having enough money to pay for what you need.
And to think about this risk constructively, you need to know: 1) what you need, 2) how much money it costs, and 3) the probability of having enough money based on your financial plan.
I talked about my personal situation here.
Another way to think about risk is time.
In the short term, the safest asset class is often cash.
In the long term (10+ years), cash is a terrible thing to invest in.
Shares are the opposite. Due to their volatility (they can go up or down considerably on a day to day basis), shares are dangerous in the short term.
However, over 20-30+ years, the stock market is probably one of the safest things to invest in, as the ups and downs smooth out into an upwards curve over time.
Yet another aspect is diversification. Generally speaking, having different investments and asset classes in your portfolio can give you a similar return and reduced volatility.
The big profits come from betting big on one or two shares.
Screenshot from A Wealth of Common Sense
On the other hand, most individual stocks underperform US treasuries. So there’s a very real danger of striking out if you swing for the fences here.
Investing in low-cost index funds is probably the best option for amateur investors. This isn’t what I have done in the past, but I am becoming increasingly convinced that it is the right thing to do and will do it more in the future.
After all that, however, I think the worst thing you can do is not think about this stuff. If you take a bit of time to think about your situation and decide everything is on track, great.
If you find there is going to be a problem down the road, you can take action to start making the situation better.
But if you never think about money, you could end up with an unpleasant surprise. And that is the biggest risk of all.
I’m still trying to figure this stuff out. What do you think? Did I miss anything? Anything you disagree with?