In personal finance, risk management is generally thought of as deciding on a stock/bond/cash allocation in your investment portfolio. However, when deciding on a risk management strategy, more needs to be taken into consideration than your tolerance for potential losses and gains.
Consider the risk and return of your career when determining an asset allocation for your portfolio. Those who have job security (like tenured professors and government employees) may have steadier income streams than a real-estate agent who is paid with commission. If your salary changes on a monthly basis, then you’re already exposed to a certain level of risk in your financial life, and you should think twice before accepting more risks in your investments.
However, just because you want to limit volatility doesn’t mean you shouldn’t hold any stocks. Stocks and their potential for growth are important in order to maintain purchasing power as the cost of living increases. Not all stocks carry the same level of risk. When working with your advisor, consider including positions that have a lower beta, which is a ratio that professionals use to gauge the volatility of stock versus a benchmark. Better yet, consider mutual funds and managed accounts which can give you much greater diversification than just a hand-picked stock portfolio.
Generally, older investors are advised to limit the risk (and potential for losses) in their portfolio while younger investors, armed with time on their side, can usually afford to take on more risk. But a recent study published in the Wall Street Journal spoke about today’s generation of 20-30 year olds, who are reluctant to take on risk. These investors have experienced financial crisis after crisis in their adult life. Without the wisdom of experience, “long-term” is a particularly difficult concept to digest, and as such, these investors are especially likely to make investment decisions based on recent events. However, they are limiting exposure to market volatility at the wrong time in their life.
Just like taking on too much risk is a bad choice, taking on too little risk could also be considered a poor decision.