Mastering The Art Of Financial Risk Management
Financial Planning
June 1, 2023
In today’s ever-changing financial landscape, the need for effective risk management has become more crucial than ever. It’s not just about making smart investment decisions; it’s about protecting your hard-earned money from unexpected market fluctuations, economic downturns, and unforeseen events.
In this guide, we will explore the three essential risks to consider so you can be better prepared to navigate the complex world of finance.
3 Types of Financial Risk
There are 3 main things to be aware of when mitigating financial risk.
Risk #1: Industry & Company & Credit
The primary way that we deal with industry, company, and credit risk is to thoroughly research mutual fund managers. We look for ones who we believe have strong risk management policies in place. Basically, we are looking for professionals whose research screens out most stocks and bonds that are more likely to lose value than gain it. Of course, you can’t bat 1000%, but you can greatly reduce the chances of loss with enough research upfront.
Risk #2: Liquidity
Another factor to look at is whether you can access your money when you need it. This is referred to as “liquidity risk.” In assessing the inclusion of a particular investment in a portfolio, it is critical to keep in mind when you’ll need that money and whether or not that specific investment will allow you to withdraw it in a timely manner.
Risk #3: Inflation & Interest Rate
These two are inextricably linked. For most of the last 15 years, the Federal Reserve (Fed) set its key rate at 0%. This was highly unusual and, in our minds, it was clear that the only direction interest rates could move was up. Inflation is tightly related to interest rates. So when inflation becomes a problem, the Fed raises interest rates to get inflation under control.
Inflation has not been an issue for most of the last 40 years, but imbalances during the pandemic began to produce inflation. The Fed was slow to raise rates initially because they believed inflation would be a short-lived remnant of the COVID era. Finally, in the Spring of 2022, they realized that inflation was not going away, and they began raising rates. As of their July 2023 meeting, the rates are at 5.25%, the highest interest rates since the pandemic. This is one of the fastest rises in the Federal Reserve Rate ever, and it resulted in declines of nearly 30% for stocks and 13% for intermediate term bond funds during 2022.
Luckily for our clients, our awareness of these risks allowed us to sidestep much of the decline in these markets by minimizing ownership of stocks and allocating nothing to long-term bonds (which are hurt the most by rising rates).
Managing Your Financial Risk
We encourage to do your own research to assess your economic and investment risks. But if you get to the end of this guide and think, “Can’t I just pay someone to manage my risk for me?” The answer is, yes you can! At JourneyTree, we spend a lot of time thinking about financial risks on behalf of our clients to ensure their interests are adequately protected. We sometimes joke that we should wear buttons that say, “Paid to be Paranoid.”
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