The possibility of unforeseen financial risks keeps many of us up at night. If you’ve ever been dealt a financial curveball—or you simply live in fear of one—you may be looking for some guidance on how to best prepare for the future or get yourself back on track.
The truth is, curveballs will always be a part of life. The best we can do is create a plan to deal with curveballs, even if we can’t anticipate what those curveballs might be. An important place to start is understanding the risks you face.
What Is Event Risk?
Event risk is a term commonly used by businesses to refer to any potential unexpected occurrence or event that will negatively affect the company.
But in today’s blog, we’re not talking about event risks for companies.
As an individual, you also deal with event risks in your everyday life. Various life hardships can affect your financial situation such as a bad investment, a medical emergency, a job loss, or even a global pandemic. These are risks we all face. Luckily, there are things we can do to plan for them.
Companies categorize several different types of event risk to plan for and strategize against them. For our purposes, we’re going to look at three categories of event risk that are especially relevant for individuals:
- Opportunity risk
- Operational risk
- Risk of uncertainty
It’s important to understand event risk in order to be better prepared. Being aware of the risks you face is critical in being able to minimize the consequences when curveballs do strike.
1. Opportunity Risk
Opportunity risk refers to the uncertainty we face in making a decision between two different choices, especially if the choice we make ends up performing more poorly than the other choice. For example, in choosing to allocate your money to a particular investment, you run the risk of losing out on a better return in an alternative option.
We constantly have to decide between different opportunities, so opportunity risk isn’t something that can be avoided. However, developing strategies to efficiently weigh different opportunities can help you become a more confident decision-maker.
2. Operational Risk
Operational risk is related to day-to-day activities. It is often considered by companies to be one of the most dangerous forms of risk, as it’s caused by the processes, people, or technology vital to the smooth operation of a company. For example, a company may find itself at higher risk of operational disasters if they employ under qualified staff members.
From an individual perspective, operational risk may happen when you’re not aware of how your day-to-day decisions are affecting your life in the bigger picture. If you routinely make the choice to eat unhealthy lunches instead of healthy lunches, you may increase your risk of chronic illness in the future. If you routinely make investments without a sound investment strategy, you may increase your risk that your investments won’t ultimately help you reach your goals.
3. Risk of Uncertainty
The risk of uncertainty refers to the possibility for any unknown event to negatively impact the financial situation of an individual or a company. Some examples of this are natural disasters, fires, and market downfalls. The risk of uncertainty may be the thing that causes many of us to feel the most fear when it comes to our finances, as these are things that can’t be predicted.
As an individual, there will always be uncertainty in your life. You can’t know for sure when a medical emergency will affect you or a family member. You also can’t know for sure if you’ll experience a job loss or layoff—the pandemic reminded us that no matter how secure we feel in our careers or our finances, something unexpected can always put that security at risk.
Recovering From Life’s Financial Curveballs
Of course, recovering from life’s financial curveballs is easier when you make plans to deal with event risks before they happen, such as saving an emergency fund. But if you’ve already been dealt a bad hand by life, there are still some important steps you can take to begin getting in control of your financial situation.
Review Your Finances
The first step is to get a clear overall view of your financial situation. Some notable areas to look at are your spending rates, your savings rates, your current investments, and your insurance coverage. You should also review your credit report and make sure that everything is accurate.
Reviewing many aspects of your financial situation can help you anticipate how well you would be able to weather the storm if life throws you a curveball. If the outlook isn’t good, you know it’s time to create a better plan. If you’re in the middle of dealing with a curveball, a thorough review can give you more insight into your options as you recover.
Create a Budget
Whether you’re dealing with a difficult financial situation or just preparing for the future, it may be time to revisit your household’s budget. A budget of any sort is a useful tool to understand how much of an emergency fund you need, how you can increase your savings and investment rates, or how you can curb your spending if you need to.
Depending on the current state of your finances, you can create a budget that simply gives a high-level overview of your monthly/annual spending, or your budget can be more detailed.
Avoid Dipping Into Retirement Funds
Taking money from your retirement investments can be a tempting way to cover financial obligations in an emergency, but you should avoid dipping into retirement funds if possible.
Withdrawing retirement funds early can result in hefty penalties and can jeopardize your long-term retirement goals because that money is no longer earning compound interest. (Plus, you may end up owing extra income taxes that year.)
Managing Risk and Planning for Curveballs
If you’ve recently pulled yourself out of a challenging financial situation and don’t want to experience the same turmoil in the future—or if you’re looking to prevent one before it happens—here are a few more things you should consider.
Review Your Insurance Coverage
There are a few financial hardships no one really expects to happen to them, such as a house fire. But house fires do happen, and you absolutely want to be prepared if it happens to you.
This is why insurance is so important. Whether it be a natural disaster, a medical emergency, the loss of a loved one, or something else, insurance can provide some security as well as some financial relief in an emergency situation.
Review each of your insurance policies carefully to make sure you’re properly covered. Health insurance, life insurance, auto insurance, and property insurance are essential. You may also want to consider other types of insurance such as accident insurance, umbrella insurance, or flood insurance depending on your situation.
Save an Appropriate Emergency Fund
As stated above, another way to be more prepared for potential risks is by setting aside savings in an emergency fund. These savings should be enough to get you through at least three to six months of expenses without additional income—although some situations warrant saving more. You should discuss a target emergency fund with your financial professional to determine how much is right for your circumstances.
Eliminate High-Interest Debt
If you’ve had to take on any high-interest debt, it’s vital for your future financial health to eliminate that debt as soon as possible. (And if you don’t have high-interest debt, it’s something you should avoid altogether.) Eliminating high-interest debt can provide you with more financial flexibility if an emergency occurs down the road, as you won’t have to worry about those expensive payments.
While some debt is relatively low-cost, you should determine if you have any debts with interest rates that are higher than average market returns. Determining this can be a tricky process. Your financial professional can help you strategize what debt should be paid off quickly, and when it would be better to increase your investments.
Create a Plan to Recover From a Financial Curveball With Caviness Wealth Management
At Caviness Wealth Management, we understand that life can present all sorts of challenges and hardships. We want to help you work toward financial stability and success. As a hands-on wealth management firm, we get to know you as an individual to help you plan for your financial future using custom strategies and recommendations. To see if we can help you recover from or prevent one of life’s financial curveballs, click here to schedule a conversation today.
Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual.
