Read a great book over the weekend – Fatal Risk: A Cautionary Tale of AIG’s Corporate Suicide by Roddy Boyd. Just buy the book, its full of wisdom. One of the many things that jumped out at me was how deeply Hank Greenberg, who made AIG into the powerhouse it became before the fall, was acutely aware of risk.
He had a great principle that everything in finance is about Financial economics (will it make money) + Operational matters (can you execute it) + risk. The first two are solvable, risk is where the challenge lies. His attitude with risk was – you hedge it, book adequate reserves against it or exit the position, pick one. This got me thinking on a personal level, what are the risks that you face and what can you do about it.
Career risk/employment risk
Sometimes bad things happen. Economies crash, business’s collapse (2001 and 2008) and you are out of a job. Two ways to hedge against this
- Always be learning. It’s your job to keep current with what’s happening around you. Always be doing a competitive analysis – is what I am doing valuable? Am I getting results that are valuable in the broader market?
- Have a personal margin of safety. Always have enough cash on hand. Nothing is more important than liquidity in hard times. Liquidity allows you to ride out the bad position. More here.
Income concentration risk aka paycheck risk
If you work for a public company you probably have the option of participating in an employee stock purchase program, have restricted stock granted to you as part your compensation and can buy company stock in the 401k plan. This is a concentration risk that you should not ignore. You don’t want all your income sources tied to your company’s equity. The question you should ask is – if you were given a cash bonus would you turn around and buy your company stock? It is best to diversify and only have exposure to your company via your paycheck, sell the espp and rsu’s, take the cash and deploy elsewhere.
Insurable risk (physical goods)
This is the classic use case for insurance. Make sure the things that matter are insured -property, life insurance if you have dependents and cars.
This is a significant risk that everybody ignores. Obviously, health insurance is a great hedge but the real way to hedge this way is to eat healthy, exercise and avoid obvious risky positions like smoking and riding motorbikes 🙂
Living debt free is best, however in reality you cannot escape taking on debt. Student loans, mortgage, car loans – all of these happen. Leverage by itself is not bad but coupled with other things such as loss of primary income – causes it to be fatal. Two ways to hedge this risk
- Make sure the debt you are taking on is serviceable with your current income level with some built-in cushion. i.e your debt payments should eat up all your after-tax income.
- Make sure debt payments are accounted for in your margin of safety cash calculation.
Diversified investments are better than concentrated bets. For most investors, passive low fee investments are better than active. A blog post earlier.
This is an interesting side effect that occurs as a result of taking action on the investment risk. If you believe in index funds, Vanguard is the cheapest and best index investment provider. However, if all your assets are in Vanguard (either directly or via another provider that purchases vanguard funds) – you are facing massive exposure to vanguard! This is one risk i’m uncertain on how to hedge. You could split your investments into different funds that track the same index (S&P for example) but will probably end up paying higher fees than vanguard. Is it worth the tradeoff?
Any other risks that come to mind? Would love to hear them in the comments/twitter (@rnsharma)