Risk Mastery: The Key to Sustaining Wealth

What comes to your mind when you think of the word, “risk?”

Maybe when you hear the word “risk”, you think of the word danger, or the potential for of an undesirable outcome to your health, wealth or time.

Or maybe when you hear the word, “risk”, you think of all the possibilities associated with potential outsized financial gains as you put some of your money on the line for a solid investment.

Either way, whether you see it as a danger keep away from at all costs or an opportunity to make money, moving through risk carefully can open up a world of opportunities for you when approached thoughtfully.

Indeed, risk is like a powerful and unpredictable ocean wave faced head on by a skilled surfer. And, just like that surfer, when you skillfully navigate it, harness its energy and ride it skillfully, you can experience an exhilarating surge that propels your life forward, allowing you to reach new heights that you otherwise wouldn’t have been able to experience.

However, if you underestimate its strength or fail to maintain your balance on life’s surfboard, then that same wave can quickly overpower you, pull you underwater and humble you in an instant.

Indeed, just like riding the waves of your own life, sometimes you need to know which risks to take and which to avoid, how to prevent unnecessary losses when you do take risks as well as being prepared for when life throws you an unexpected curveball.

That’s why when it comes to achieving and maintaining financial independence, being able to master the way you prepare for risks is key to sustaining the wealth you build along the journey.

Knowing Which Risks to Avoid

Alright, so then how can you approach risk in a way that allows you to get around significant financial derailers? Well, one of the first ways is to know which risks to avoid in the first place.

And how do you do this? Well, imagine yourself standing before a steep cliff.

In this situation, risk avoidance is like choosing not to approach the cliff at all, and instead sidestepping the potential danger completely. Here what you’re doing is making a conscious decision to avoid the situation that poses a risk, thereby eliminating the risk from your reality.

Now, it’s crucial to note that on the one hand, this method completely removes the possibility of a risk event occurring, but at the same time, it eliminates the potential benefits that may come with it.

Avoiding High Risk Investments

For example, picture yourself facing a host of investment opportunities as you get ready to put your money to work. Now, the potential for profit is vast, but so is the risk, right? And so, does that mean you stay out of the markets entirely if you want to avoid risk?

Well, not necessarily.

Instead, when you know which risks to avoid, you might choose to stay away from certain investment vehicles known for their high volatility or uncertainty, like speculative stocks or cryptocurrencies, even if their potential returns are substantial. That’s because the goal here is to shield your hard-earned money from potentially devastating losses, and thereby opting for stability and security rather than unpredictable high gains.

Prudent Borrowing and Risk Avoidance

In a similar way, you can think of risk avoidance as an approach for thoughtfully using debt. For example, as a tech professional or business owner, you may be tempted to leverage debt to accelerate your wealth-building journey. And this could come from using margin to boost investment holdings.

Now, in this situation, while you have the potential for a massive gain in the markets based on a speculative bet, in many situations, excessive leverage is fraught with risks, including increased financial strain and the potential for bankruptcy. That’s because all it takes is one big market move in the wrong direction and that’s it, a margin call puts you out of business.

That’s why when you practice risk avoidance, what you’re doing is opting to maintain a prudent borrowing level with your investments, which ensures that even in worst-case scenarios, such as a market or economic downturn, you can stay in the markets without crippling your financial future.

Risk Avoidance in Business Ventures

And for you business owners out there, you’re likely to face numerous risks that can lead to operational setbacks in the best situations, and potential lawsuits in the worst. So then, in this situation  practicing risk avoidance means choosing not to engage in potentially risky ventures or taking on clients that could jeopardize your business.

And what are we talking about here?

Well, a crucial part of effectively managing your business is knowing when to accept a client and when to walk away. You’ll have to accept that not all clients are beneficial to your business, and, in fact, some may even pose considerable risks.

For example, consider a scenario where a potential client consistently has trouble paying their bills on time. In this situation, you might be tempted to accept the job, considering the potential for increased revenue down the road. But the reality is that this relationship could lead to cash flow issues in your business when their payments are delayed or, worse yet, never arrive. Therefore, by having a process to identify such problematic clients in the first place, and choosing not to work with them, you’re proactively avoiding unnecessary financial risks.

Either way, risk avoidance isn’t about dodging all financial decisions that carry any risk. Instead, it’s about making informed choices that limit your exposure to unnecessary, potentially catastrophic decisions. To be sure, as a high earner, risk avoidance is a fundamental principle that you should be familiar with as a way to ensure that your financial health remains strong, regardless of what may come in uncertain market, economic or business conditions.

Preventing Unnecessary Losses

Alright, so, now that we’ve discussed how avoidance can help you side step unnecessary risks, let’s talk about risk prevention.

And how is risk prevention different from risk avoidance?

Well, as we highlighted earlier, risk avoidance is like seeing a cliff and choosing not to approach, right? Well, risk prevention is the process of putting barriers around the cliff, which allows you to approach without getting too close to the edge. Here again you’re not avoiding the cliff entirely, instead, you’re implementing measures to stop the risk from taking place in the first place.

And what are we talking about here?

Strategically Reviewing and Adjusting Investments

Well, when thinking about investments, risk prevention means more than just wisely choosing where to put your money, or which sectors of the markets to avoid. Indeed, risk prevention also involves regularly reviewing and adjusting your portfolio based on market trends and your personal financial goals.

For example, if you’ve experienced a period of strong market gains, and anticipate a significant market downturn, you may want to rebalance your portfolio by reducing holdings where you’re overallocated, or adding to positions where you’re underallocated relative to your strategic asset allocation decisions. And why is this important? Well, by rebalancing your portfolio, what you’re doing is preventing potential losses from being overexposed before an inevitable market downturn takes place.

Proactive Debt Management

And when it comes to borrowing money, risk prevention is about being proactive about the way you manage your debt by putting measures in place to address the unexpected.

So then, if you do decide to use margin to boost your overall investments, this might mean understanding this historic volatility of the asset you’re borrowing against, exploring worst-case volatility scenarios, and knowing how to size your positions before putting your money to work.

Implementing Safety Protocols in Business

In the context of a business, risk prevention might mean putting in place protocols to prevent potential financial risks before they turn into real problems. And what do we mean here?

Well, you’ll likely recall in our earlier example how we discussed the benefits of avoiding risky clients altogether. Now, if you do decide to work with clients who might seem risky, it’s important to establish clear, contractual agreements that spell out the expectations and responsibilities of both parties.

For example, let’s say that you’re dealing with a client with a history of delayed payments. So then, one way to mitigate this risk includes strict payment terms in your contracts, like requiring a substantial deposit upfront from risky clients or implementing a policy to charge additional fees when your payments are late. These sorts of provisions, while not always perfect, may help to incentivize prompt payment and protect your business from significant cash flow issues down the road.

Either way, risk prevention is about setting up guardrails, or putting processes in place, that allow you to take certain risks without getting burned.

Prudently Dealing with Unavoidable Risks

Alright, so we’ve talked about avoiding and preventing risks, what do you do in situations where a potential loss is going to come your way no matter how much you try to avoid or prevent it?

Well, that’s where risk mitigation comes into play. And what is risk mitigation?

Well, risk mitigation is like looking at that cliff, and, with the right equipment and safety gear, choosing to descend it ever so carefully. Indeed, in this situation, you’re aware of the risk, yet you decide to engage with it in a measured and calculated way.

Indeed, risk mitigation enables you to reduce the severity of a potential loss, without removing the risk entirely. In this situation, what you’re doing is accepting that the risk is there but you’re taking steps to lessen its potential impact on your overall financial well-being.

How so?

Well, this might mean taking out insurance, establishing contingency plans, or allocating resources strategically to reduce risk.

And what does this look like?

Investment Diversification and Hedging

Well, from an investment perspective, risk mitigation might mean strategically spreading your investments across different asset classes, like stocks, bonds, real estate, and others to diversify your investment portfolio.

And this approach can help reduce your vulnerability to a single concentrated stock, and minimize potential losses when markets head south without necessarily compromising on potential gains.

What’s more, you could consider hedging strategies for your investments that further allow you to protect investment holdings as you work your way towards diversification.

Professional Liability Insurance for Risky Ventures

And for you side hustlers or business owners out there, if you do decide to work with otherwise risky clients, you should consider insurance policies to help defray potential financial costs associated with these sorts of engagements.

More specifically, in this situations like these, what we’re talking about is professional liability insurance, also known as errors and omissions insurance, general liability insurance, and in some cases, specific coverage like malpractice insurance for healthcare providers or legal professionals.

And why would you want this kind of insurance?

Well, let’s imagine for a moment that one of your clients claims that an error in your service caused them financial loss and decides to sue you. In this case, your professional liability insurance would typically cover legal defense costs, as well as any damages or settlements that you’re otherwise required to pay, up to the policy limits.

And how does this help when working with high-risk clients?

Well, high-risk clients often have more at stake, are more demanding, or are more likely to resort to legal action if something goes wrong. That makes them a liability risk. For example, you might be a freelance software developer working on a significant project for a high-profile client. If there’s a delay in delivery or a bug in the final product that causes the client to lose revenue, they could sue you for the losses.

So then, in this situation, having professional liability insurance would be crucial in protecting you from the potentially massive costs of a lawsuit.

In a similar way, if you’re a consultant giving advice to clients, and one of them claims that following your advice led to a business loss, professional liability insurance would step in to cover the costs associated with defending against such a claim and any resulting judgment or settlement.

Therefore, by having professional insurance, you create a safety net for your business. And, it gives you the confidence to take on higher-risk clients, knowing that if something goes wrong, you have some sort of financial protection in place. Now, with all that said, it’s crucial to note that you need to understand the coverages, limits and exclusions of your insurance policy to ensure it aligns with your business needs and risk profile. So then, if you haven’t already, be sure to check out our recent discussion on buying insurance like a pro.

Risk Mastery: The Key to Sustaining Wealth

Now, when it comes down to it, mastering risk is the key to sustaining the wealth you’ve accumulated along your journey to financial independence. To be sure, whether risk evokes thoughts of danger or opportunity for you, approaching it with care and thoughtfulness can nevertheless unlock a world of possibilities. And like a skilled surfer riding a powerful wave, navigating risk skillfully can propel your life forward, allowing you to reach new heights. But with that said, underestimating its strength and losing your balance can lead to being overwhelmed and financially humbled in an instant.

That’s why, to become the master of your financial independence journey, it is crucial to know which risks to avoid. Remember, risk avoidance isn’t about dodging all risky financial decisions, but rather, it’s about making informed choices that limit exposure to unnecessary and potentially catastrophic risks. It could mean sidestepping certain investment vehicles known for high volatility, avoiding excessive leverage, and for you entrepreneurs out there, being selective with clients who pose considerable risks to your business.

At the same time, you’ll want to take into consideration risk prevention, which, just like navigating a cliff’s edge involves putting barriers in place and adjusting your strategies to avoid being too close to the edge. This might involve frequently reviewing and rebalancing your investment portfolio based on market trends and conditions. It could also mean establishing clear contractual agreements, maintaining open communication with clients, and utilizing risk prevention measures to safeguard your business and prevent adverse events from materializing.

And finally, there will be inevitable risks that cannot be avoided and this is where a solid risk mitigation strategy comes into play. Remember, mitigation involves accepting the presence of risk while taking measured steps to reduce its severity. And from an investment perspective, these strategies include diversifying your investment portfolio and employing hedging techniques. And from a business perspective, professional liability insurance, can protect you and your business against claims and financial repercussions arising from errors or omissions when working with risky clients.

Either way, risk doesn’t have to be something that keeps you up at night if you know when to avoid, prevent or mitigate them. Indeed, the process of mastering the risks in your life allows you to take one step closer to becoming the master of your own financial independence journey.