When we hear the word "risk," many of us automatically think of market risk—the possibility of losing money due to fluctuations in the financial markets. While market risk is a significant consideration, it is essential to broaden our understanding of risk when it comes to achieving our financial goals. At Certus, we firmly believe in the importance of understanding the various types of risks. By empowering our clients with this knowledge, they can make informed decisions and take proactive steps to grow their net worth in alignment with their unique objectives. In this post, we will explore the different kinds of risks, the significance of understanding market risk, and how to build resilience against risk to achieve financial success.
Defining Risk: More Than Market Volatility
Often, people associate risk solely with the uncertainty and volatility of the stock market. While market risk is undoubtedly a relevant factor, it is not the only type of risk that can impact financial well-being. There are several other risks that individuals must consider in their financial planning:
Longevity Risk: This risk refers to the possibility of outliving your savings. With increasing life expectancy, ensuring that your savings and investments can sustain you through retirement is crucial. Moreover, it’s important to note that expenses consistently rise over time, directly affecting the potential duration of one’s savings.
Inflation Risk: Inflation can erode the purchasing power of money over time, potentially reducing the value of your savings and investments. If your earnings and investments fail to outpace inflation, you may find it challenging to maintain your standard of living in the future. Did you know that from 2013 to 2020, the average inflation rate was 3.1%? What this means is that your expenses will increase by 50% over the course of about 13 years.
Interest Rate Risk: Recently, we have been experiencing a higher level of inflation, resulting in the Fed increasing interest rates. Fluctuations in interest rates can affect various aspects of your financial life, including the cost of borrowing, the returns on your investments, and the price of assets like bonds. Being cyclical, as inflation moderates or falls beneath the Fed’s target of 2%, we would anticipate that interest rates would fall (although not to the historically low level we have previously experienced).
Liquidity Risk: Liquidity risk involves the potential difficulty in selling an asset quickly without significantly impacting its price. Illiquid assets can tie up your money and limit your ability to access funds when needed. Examples of illiquid investments include private equity, private credit, and/or rental properties. While these are all viable investment options, it’s important to understand one’s need for liquidity.
Understanding Market Risk
Market risk is one of the most discussed and widely recognized risks. It refers to the fluctuations in the prices of financial assets due to changes in economic conditions, geopolitical events, company performance, and investor sentiment. Understanding market risk is vital for every investor, as it allows us to develop a realistic perspective on investment outcomes.
Market risk can be mitigated through various strategies like diversification, asset allocation, and investing for the long term. A well-diversified portfolio, which spreads investments across different asset classes, helps to reduce exposure to any single market's volatility.
Embracing Risk Tolerance
As investors, we must recognize our individual risk tolerance—the amount of risk we are comfortable taking on. This is a personal and dynamic aspect of financial planning, influenced by factors like age, financial goals, investment timeline, and emotional temperament. By understanding our risk tolerance, we can create a balanced portfolio that aligns with our long-term objectives and implement strategies that are sustainable over time.
Building Resilience Against Risks
To ensure that we are on track to accomplish our financial goals, we must implement strategies that account for the various risks we face. Here are some steps to build resilience against risks:
Diversification: Spread your investments across various asset classes and industries to minimize exposure to any one market risk factor.
Regular Review: Periodically review your financial plan and investment portfolio to ensure they align with your changing life circumstances and goals.
Liquidity Considerations: Maintain an emergency fund with at least three to six months' worth of living expenses to handle unexpected events without disrupting your long-term investments. Consider obtaining a line of credit which could further enhance flexibility and liquidity.
Professional Guidance: Consult with a financial advisor to develop a comprehensive financial plan that addresses your unique needs and goals. Your financial advisor should partner with your tax advisor to address tax implications not only today, but also in the future.
Conclusion
While market risk is often the first risk that comes to mind, it is just one piece of the broader risk landscape that we must navigate in our financial journeys. By understanding and addressing the various types of risks, we can build a robust and adaptable financial strategy.
Knowing our risk tolerance and adjusting our investments accordingly empowers us to make informed decisions that will propel us towards growing our net worth confidently in order to achieve our financial dreams. Knowledge is power, and the better we understand risk, the better equipped we are to achieve our financial aspirations.
To discuss your unique goals and objectives, contact us today.
This content is provided for educational purposes only, represents only a summary of topics discussed, does not constitute any personalized investment advice or recommendation, and represents only the views and opinions of the speakers which are subject to change without notice. Investing involves risk including the potential loss of all amounts invested.
This material prepared by Certus Wealth Management, LLC (“Certus Wealth”) is for informational purposes only. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Opinions expressed by Certus Wealth are based on economic or market conditions at the time this material was written. Economies and markets fluctuate. Actual economic or market events may turn out differently than anticipated. Facts presented have been obtained from sources believed to be reliable. Certus Wealth, however, cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Certus Wealth does not provide tax or legal advice, and nothing contained in these materials should be taken as tax or legal advice.
