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Thursday, November 27, 2014

You are never going to escape risk

An old saying goes that there are only two things guaranteed in life. Death and taxes.

These are the only two guarantees you get in life. You can plan everything else and it might not go as planned.

When I think about this in the term of financial planning, I realize that there is no perfect go to investment or strategy. Everything has an element of risk, some much more than others.

1. Starting up your own business.
This is one of those risks that can go really wrong but it is easily avoidable. You only face the risks if you start your own business. If you don't make enough money in sales or services, you face the risk of going bankrupt if you are a sole proprietor. You also face legal risks if someone gets hurt on your place of business and you get sued. These risks can be mitigated by incorporating your business and making it a separate entity but then there also comes the frustration of complying with government regulations and paying and filing taxes correctly. If you don't run your business the way the government wants you to then you face the risks of being audited by the IRS and paying fines.

2. Stocks
When most people want a way to make money by doing nothing, they throw it into stocks hoping the values go up and they can sell it at a higher price for a profit. Obviously, you take a risk if your stocks plunge in value after you buy them. The biggest risk is if the company goes bankrupt and you lose all the money you paid for the stocks and have no way to recover any portion of it. Just like owning your own business, this risk only exists if you invest in stocks.

3. Real Estate
The risks that come with real estate are very similar to owning your own business. The most common ways people try to make money with real estate is fixing up a house and selling it for a profit or owning a house and renting it out. In the case of a fixer upper, you may have to spend a few months or a year fixing up a house and then you have to find a buyer willing to buy at a high enough price. An underestimation of how much it takes to fix the house and an overestimation of how much you think you can sell it for can result in losses on your original investment. When it comes to rental income, you need to have reliable tenants. Jerk tenants may end up not paying rent and not leaving or trashing up the house.

4. Government sponsored retirement plans (401k, IRA, etc)
Most people invest in these plans because these are the "smart" things to invest in because of tax benefits. The risk you face here is that these programs invest money mostly in stocks and you don't know what the performance will be in the future. On top of that, these plans can come with administration fees that have to be paid every year despite how well the plans perform. Lastly, a bigger risk is that the federal government is fiscally irresponsible and may decide to nationalize these plans, rescind the tax benefits, or just steal this money to help pay off the national debt.

5. Gold, silver, and other precious metals
These precious metals are commodities. The only way you can really make money with precious metals is selling them for a higher price. Just like stocks, you don't know how they will perform in the future. The additional risk comes in the fact that precious metal is real. If you order precious metals, there is a risk that it is counterfeit. The other risk is storage. You want to make sure to have a safe place to store the items otherwise someone could steal your metals.

6. Bank deposits and fiat currency
Even just holding cash, CD's, and bank accounts hold risks. The federal government has the power to print off more money which indirectly leads to inflation. Just holding currency for years will result in the loss of purchasing power. Now, bank deposits hold the risk that they can be stolen from you from the federal government if you owe back taxes, child support, etc.

Realize that, no matter what you do, there is always some risk that comes along with it. Don't let risks stop you from living your life but just be aware of the risks you face and do the things that you can to mitigate the risks.

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