Four Financial Risks Worth Taking
Fee-for-service financial planner and founder of PlanEasy.ca
Sometimes you have to take a risk. But not all risks are created equal. Some risks have rewards that greatly outweigh the potential downside. These risks can pay off big-time down the road, but its important to pick the right ones.
When it comes to personal finance there are lots of risks (and lots of rewards!). Taking a few strategic risks can do wonders for your long-term personal finances. But it’s important to understand the trade-offs.
Almost nothing in the world of personal finance is completely risk free (except maybe a guaranteed deposit with an insured bank) but there are four financial risks that can be worth taking.
If you understand the potential downsides, these financial risks can have a huge positive impact on your finances.
Disclaimer: Always understand your own risk tolerance before taking on any financial risk. Your health and happiness is worth more than a bit of financial gain. Understand the pro’s and con’s before taking on any risk.
Risk #1: Having A High-Risk Portfolio While You’re Young
One risk potentially worth taking is to have a high risk portfolio while you’re young. A “high-risk portfolio” is one that has 90% or more invested in stocks. (A high-risk portfolio is NOT when you invest in just a few stocks hoping for a home run, this kind of risk isn’t rewarded).
A high-risk portfolio may also contain a heavier weighting towards small cap stocks or may use tax advantaged leverage like in the Smith Maneuver to increase your risk even further. These strategies have the potential for higher returns but historically come with higher volatility too (especially when using debt/leverage).
Taking on this extra volatility is risky. It can be a gut-wrenching ride and it’s not one that many people can stomach. There is a greater chance of losing a large portion of your portfolio. There is also the risk of panic selling on the way down and not benefiting from a potential recovery.
Thankfully when you’re young you have time on your side. There is time to recover from a large loss, if you’re able to stomach the ride. This is why having a high-risk portfolio could be an acceptable risk while you’re young.
The key is that it “could be” an acceptable risk, but not always, and not for everyone. Everyone’s risk profile is different. Always understand your investment goals and risk tolerance before making any investment. High risk investments should be long term in nature, 15-20 years or more and they should always be in line with your personal risk profile.
Investment risk should also be in line with your long-term needs. Remember, there is no reason to take on more risk than you need to achieve your goals.
Risk #2: Buy A House With Less Than 20% Down
Many of us have a goal to put 20% down on our first home (we sure did when we bought our first home). This is a noble goal, but getting into the housing market with less than 20% down might be worth the risk.
Buying a home with less than 20% down means you can start building equity sooner. It might let you take advantage of an opportunity to purchase the perfect home now, an opportunity that may not present itself in the future. It also may help protect you from future price increases (although this is very speculative thinking).
Plus, buying a home with less than 20% down might be the right move for your life. If you have a young family then you may value the stability that comes with owning a home. There is no chance of your family being forced to move, having to change schools, or having to re-build relationships with new neighbors etc. etc.
Remember, buying a home involves many financial (and non-financial) considerations, and the size of your down-payment is only one of them. If by all other metrics your home purchase is a great decision, then buying a house with less than 20% down might be worth the risk.
Risk #3: Actively Switching Jobs/Employers
Switching jobs frequently can come with a large pay increases but it can also feel very risky. There are potential unknowns like the company culture, work life balance, future career opportunities, friendly colleagues etc. These are some of the risks you take when switching jobs.
This fear of the unknown keeps many people in their stable but underpaying jobs. Taking a risk and switching jobs can be stressful but often very lucrative.
Switching jobs every 2-3 years has been shown to increase your salary faster than those who stick with their current position. These increases can add up quickly and after 10-years can mean a 50%+ difference in pay. When you’re in your 20’s and 30’s the average increase in income is around 7% per year and could be even higher with aggressive job switching.
Changing roles or changing employers, can be risky, but over the long-run there is a big potential reward.
Risk #4: Having A Small Emergency Fund While Paying Off Debt
Having a fully funded emergency fund is a great way to reduce risk. It lets you absorb financial difficulties without resorting to using credit. The general advice is that you should have an emergency fund that is between 3-6 months of expenses. This increases when you have a job with highly variable income, like commissioned sales people, or when you’re employed in an industry that has a higher risk for layoffs.
Related: How to build an emergency fund fast!
The one exception to this advice is when you have high interest debt, anything over 6-8%. If you have debt with interest rates above 6-8% your priority should be paying down your debt.
In these cases, your emergency fund should only be 1 month of expenses (or less) and the rest of the money should go towards your debt.
This increases your risk in the short-term, but the reward is that you can pay off your debt much faster by avoiding the extra interest charges. This will help you in the long-term and help build that future emergency fund even faster (here are some more tips on how to build an emergency fund fast).
Financial planner, personal finance geek and founder of PlanEasy.