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Connecting Risk And Personal Finance Habits

23 August 2010 No Comment

Risk is an interesting subject in the world of finance.  When it comes to millions of Americans and their financial objectives, it’s amazing how much risk they’re willing to take (maybe unknowingly).  The reality is that most individuals are willing to take a large amount of risk in order to make up for their shortfalls in their personal finance habits.  What personal finance habits am I referring to?  Well, mostly spending and saving – we spend too much and save too little.  As a result, in order to retire, in order to buy that big house, we need larger risk and larger leverage. 

Think about it, why would we be putting all of our eggs in the stock market via our 401(k) for most of our lifetime when we clearly see that the stock market can be very volatile and maybe manipulated.   I know your reaction to that statement is that stocks offer the best return over long periods of time, and while that may be true, most of us fail to factor in inflation to that equation and I believe that we’re at a secular turning point which will prevent the same moving forward.  If we saved more, we wouldn’t need to put as much of our assets at risk.

Now, this doesn’t mean there isn’t a place for healthy speculation or stocks, but it shouldn’t be the cornerstone of our financial plans.  I know Dave Ramsey recommends “growth stock mutual funds” for long term savings, but Dave also recommends massive cash emergency funds and paying off your mortgage (both work to reduce risk in your life). 

When it comes to buying things, namely houses, we use leverage to allow us to buy what we want and can’t afford.  Now, I have a mortgage and so do you probably and that is fine.  But, we definitely buy more than we can as a result of the mortgage and the result is much more debt in our lives (yes, a mortgage is still debt).  If we saved more, we would be able to borrow less.  A mortgage adds risk to your life – you can’t lose a paid off home to foreclosure.

Fix your personal finances habits first.  Make that your priority.  Then add risk and leverage (if you want) in moderate doses.

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