How Much Risk Can You Handle in Your Life?

by Miranda Marquit · 13 comments

We talk a lot about risk when it comes to finances, and much of the time, risk tolerance is associated with investing. However, the amount of risk you can handle also plays a role in other financial decisions and aspects of your life. Before you make decisions about what’s next, think about how much risk you can handle in your life.

Do You Have an Emergency Fund?

An emergency fund can help you handle a higher degree of financial risk. If you have a rainy day fund stored up, whether it’s in a savings account or you keep it in a taxable investment account (like I do), an emergency fund can help you bridge the gap when you end up with unexpected costs.

Another great reason to have an emergency fund is the fact that it offers you the chance to take other risks in your life. An emergency fund can help if you are hoping to quit your day job to freelance, rely on your side business, or if you want to start and build a business. You can have something to live on while you work on your dreams, but you might not be able to handle the risk and uncertainty of quitting your traditional job without that emergency fund.

What’s Your Family Situation?

When I was younger, unmarried, and childless, I was able to take more risks with my finances and in other ways. During my marriage, I made a lot of “safer” decisions based on the fact that I was the primary breadwinner. We couldn’t do without my income, so I was careful in my choices.

Even though I’m single, I still have to be careful about how I handle my money and my other life choices because I’m raising my son. I still need to make sure that I have the income available to feed not just myself but my loved ones. On top of that, I need to be careful about some of my activities so that he feels comfortable about the stability in his life.

Where Do You Live?

I have changed some things up recently, even with my son in tow. We moved to Idaho, where there is a much lower cost of living. Because of this decision, I am able to work a little less and spend more time away from the grind. My son is also able to participate in more activities because free time and more money mean more options. This has been good for both of us and it gives us breathing room. My emergency fund will last longer if there is something unexpected and I can spend more time with my son.

Do You Have Insurance Coverage?

Finally, one way to improve your ability to handle risk is to make sure you have appropriate insurance coverage. When I broke my wrist and required surgery, my health insurance coverage prevented my financial situation from becoming untenable. Paying for home insurance, car insurance, and other insurance premiums sucks but it is a good way to protect your assets from the unexpected. As you plan to reduce your risks, make sure to plan ahead with insurance and other tools. It can be a way to limit the extreme outcomes and give your budget and you peace of mind.

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{ read the comments below or add one }

  • Aziz Mahat says:

    I am barely able to do risk management. But I takes risk without thinking of Loss on investment.

  • Ryder says:

    I think you also have to pay attention to how much of your “mental space” is taken up with thinking about and managing risk in areas other than the financial sphere. If you are worried about your landlord and repairs needed to your home, and your boss, and your job, and your company, and your industry, and your kids’ school and their friends, and your need for a new car, and your relationship, then you don’t have a lot of mental space to be worried about your portfolio and investments. So maybe being a bit more conservative there makes sense until some of the other issues get resolved. Otherwise, your head may explode.

    And on the cost of living, I read those articles about how living in Mobile or Williston — or even overseas — might cost less, but I wouldn’t leave the Bay Area for anyplace else. While a house is just a house, I take some joy in the fact that Zillow and Redfin say my home is up $400,000 in value since I bought it 3 years ago. But if you’re not selling, it’s mostly going to be for the benefit of your heirs anyway. Fortunately, Prop 13 in California keeps my taxes from doubling.

    • David @ says:

      I was just talking with my wife this morning about how being worried about everything actually affects your health too, so it’s definitely worth it to avoid “having your head explode”.

      At the end of the day, you need to balance every aspect of your life and maximizing financial assets are just one part a healthy lifestyle.

  • Rick Mayhew says:

    Covering all the bases can be a challenge. For example, even if you have insurance, the deductibles might be fairly large. Earthquake deductibles can run 15% to 25%. On a $300,000 house, you would be responsible for the first $45,000 of an earthquake loss with a 15% deductible.

    • David @ says:

      I’m okay with extremely high deductibles because I treat insurance as only necessarily for catastrophic scenarios. If you can afford the copays, then you actually save much more in premiums (on a whole since chances of claiming are small) if deductibles are high.

  • Jonathan Dyer says:

    I’m always amazed at how many people don’t have an emergency fund. I also appreciate that you separate “rainy day funds” from emergency ones — just having one isn’t going far enough in my opinion.

    I also really like your point about cost of living, even if I don’t always like the think about how much I sacrifice to live in Los Angeles 😉 Great post!

    • David @ says:

      You probably love living in Los Angeles Jonathan. At the end of the day, it’s just about priorities. I like in southern California too, and I can’t imagine being happier living anywhere else. We pay more, but that’s a conscious choice that we make.

      The extra expense is worth it for us, and we have to do what works for us right?

      • freebird says:

        I guess I’m mixed with respect to risk position. I hold a lot of pink sheet microcap stocks in my investment portfolio but I also carry ample insurance and keep a high cash balance. Maybe the distinction is in the gain/loss skew– on the risks where costs can be large and outside my control even if the odds are small I stay conservative. But I’m willing to take large risks when the downside has a limit.

        And like you guys maybe the biggest risk of my life I never realized I was taking. After moving here decades ago, I liked living here so much it became my “Hotel California”. It added a few extra years of work to get the extra padding to reach financial independence once I abandoned my original plan to retire to a low-cost destination. But no regrets.

        • David @ says:

          You certainly need to know what you are doing with pink sheet stocks, so how did you get started?

          And it sounds like you established a good retirement plan. That’s awesome!

          • freebird says:

            I started out following “sell side” research reports published by white shoe firms in our business school library (even though I was an engineering student), and let’s just say that some of those high flier picks didn’t pan out and ended up in the pink sheets. To my surprise some of them recovered smartly after some quiet period in the wilderness. That’s when I realized what I really wanted was to identify the candidates and make mean reversion bets. Of course diversification is key in this space because most of these can and will wipe out. But those that recover can see pretty amazing returns. So the key is the selection criteria, and that develops by experience.

            One marker I use is in the Yahoo Finance “holdings” tab, if more than 1% is owned by Dimensional Fund Advisors, to me that’s a good sign. Not guaranteed of course but I’ve found the probability of success improves significantly when they’re on board. The rest I can’t discuss because getting sharply mispriced shares is usually challenging.

          • David @ says:

            Interesting stat of odds improving if DFA is onboard.

            I remember back in the day when I participated in a nationwide (in Canada) stock picking contest for students and landing in the top 20 because I randomly picked a microcap stock and just invested everything. It was funny because I gave up after seeing it tank, only to luck out because the stock price zoomed up right when the contest ended. The company went bankrupt 12 months after too, so that taught me to be careful investing with these types of companies.

  • Dannielle says:

    This is why I’ve been so careful with my finances over the last few years. Although I’m not married or do not have any children, I’m extremely scared to take risks. It’s not all on me though – I have a property loan and that is at the forefront right now. I wish that I could take the jump into the full-time freelance life, but so far it does not seem possible.

    • David @ says:

      It could be hard to take the leap into a full time freelance life. Find more clients, or build up your income sources more in the meantime and you can definitely take the leap then 🙂

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