The previous blog entry discussed how uncertainty makes risk seem riskier. OK–so what is investment risk? As a general proposition let’s define risk as the possibility of losing some, or all, of your investment principal.
The horrible byproduct of taking investment risk is that losses may trigger considerable regret. Had you not taken the risk, the money would still be in your pocket. Damn.
Here are some propositions for you to consider:
Proposition One: Wealthy folks don’t need to take investment risk. If you have a sufficient amount of money to support your spending and bequest needs, you don’t need to earn high investment returns. Billionaires like Bill Gates and Warren Buffett do not need to make risky investments—even if they never earn an additional dime, they will never be able to spend all of their wealth. This is why the super-rich give hundreds of millions of dollars to charitable causes. If you are super-rich, you don’t need more money. No need = no reason to take risk.
Proposition Two: The amount of risk you need to take depends on the budget required to support a target standard of living for yourself and your family. All else equal, the higher your monthly budget, the more you may need to supplement existing wealth with money earned from future investment returns.
Proposition Three: It is not just your level of spending that determines the amount of investment risk that you need to take. Rather, it is the level of spending relative to your existing wealth. If you have a million dollars and want to live in a cabin in the woods and be self supporting, you probably do not need to send much, if any, of your current wealth into the future. If you have a million dollars and want to live like Donald Trump, you probably need to consider how to fund a great many future expenses. A need for money to pay future bills = a reason to take investment risk today.
Proposition Four: Without risk there is no reward; taking risk, however, does not guarantee that you will be rewarded. The whole idea of risk is that the value of an investment might shrink instead of grow. As a consequence, you must plan your investments carefully and take only the risk that you really need to take—not too much, not too little.
Bottom Line: The first step is to figure out a budget—even if you do it on the back of an envelope. Write it down. Look at it. Chances are you’ve forgotten some important items so bump it up. Put in a margin for unexpected expenses. You are on your way to determining if you have the luxury of avoiding investment risk; or, if you need to become an investor.
This blog post is an adaptation of a similar post originally published on Mesothelioma Circle. Mesothelioma Circle is an organization focused on providing information and resources to victims of mesothelioma and their families. It is sponsored by Kazan McClain Satterley & Greenwood. Since 1974, Kazan Law firm has worked tirelessly to help the victims of asbestos exposure and mesothelioma.