Hey everyone, it’s Finance Fridays again. We’re going to make a slight departure from the more recent posts and talk about a relatively simple concept, but is worth clarifying and understanding. Today we’re going to talk about Risk and Responsibilities.
Risk and Responsibilities
As you might expect, Risk and Responsibilities share an inverse relationship, while not begin mutually exclusive from one another. In general, the more responsibilities you have, the lower the level of risk you can take. The dynamic between these two is called your risk tolerance, which is a delicate balance, hence the picture of the skateboard.
It’s probably better to illustrate this with an example.
Let’s take two young attendings, both a few years out of fellowship.
- two student loan payments
- two kids
- two childcare payments
- mortgage payment
- two car payments
- no student loans
- no kids
- no child care payments
- renting (no mortgage)
- no car payments
This example may seem kind of extreme, but it’s really not.
Attending A is me and Attending B is my friend.
Additionally, I have a lot of other friends who are somewhere in between the Attending A and Attending B prototypes.
So, let’s examine their risks and responsibilities…
He/she has a laundry list of both financial and personal responsibilities. In his/her current situation, there is a lot of money going out each month just for general upkeep, notably the mortgage, car payments, and childcare payments. Outside of the scope of “general upkeep” the student loans have the highest priority and any additional money should be going toward them every month. However, more so than the financial responsibility, he/she has personal responsibility to provide for a family which depend on them.
When you look at Attending A, his/her ability to take any significant risk is pretty limited. That’s not to say that he/she can’t take any risk, but the balancing act of risk/responsibility is pretty tenuous when the family is so dependent on them. For the most part, their risk tolerance is low. This prototypical Attending A will most likely stick to The Philosophy and The Checklist.
You probably won’t find Attending A buying Cryptocurrency, investing in Dividend Stocks, or even messing around too much with a Taxable Account.
In juxtaposition, Attending B has no huge financial or personal responsibilities. As long as he/she has good disability insurance, he/she isn’t dependent on anyone. Attending B should have a lot more disposable income than Attending A, as long as he/she doesn’t make The Biggest Mistake of Your Life .
So, this particular Attending B has very relatively few financial/personal responsibilities compared to Attending A. Other than a monthly rental payment, they can pretty much use their money on whatever they want. Their particular risk tolerance is probably higher.
It will be pretty simple for this Attending to maximize the “normal” retirement options of 401k and Backdoor Roth IRA. However, the outlets for planning for retirement “outside of the norm” are significantly more volatile. This particular Attending will probably make higher risk plays than Attending A would ever even think of. Cryptocurrency, Individual Stock Picks, Dividend Stocks, etc, are probably all things that Attending B has considered (or maybe already is) doing.
Buying a house with plans to stay in one room and rent out the other rooms is a consideration. One or multiple investment properties are also a consideration. The list goes on.
However, just because he/she can, doesn’t mean he/she should.
What do you mean?
Life comes at you fast. Attending B may become Attending A faster than they may think.
If Attending B meets Mr or Mrs Right and starts a family, then their list of personal/financial responsibilities will increase significantly. Or, if there is illness in the family and the family needs help, then their list of personal/financial responsibilities will also increase significantly. Life comes at you fast… and is shorter than you think.
All of those more risky investments back when Attending B was a young attending may be too risky now. However, based on what the stock market, cryptocurrency market, or housing market is doing, that money may not be immediately retrievable. Attending B may have been stretched too thin with too much money spread around in different avenues that can’t be immediately accessed.
Is it probable that Attending B is stretched so thin he/she couldn’t get enough money out to cover these new financial/personal responsibilities?
However, it’s not impossible.
I guess what I’m trying to say is that Attending B has a higher risk tolerance, and that’s understandable. But even with all that extra disposable income, I think it’s not a good idea to “run on empty”, meaning living month to month to cover all your investments, or be so heavily leveraged into properties that you could potentially be foreclosed on by a few missed rental payments.
At the very least, I think Attending B should have a sizable chunk of money in index funds within a Taxable Account that they can withdraw from if needed. Is it optimal to pull money out of a taxable account “because you need it”.
However, I think it’s much better than trying to sell a house in a down market or trying to sell crypotocurrency at a moment’s notice because you need to.
Just remember, only gamble with money you’re ok losing.
However, what you’re “ok losing” can change in the blink of an eye, and I caution Attending B against that possibility.
The amount of risk you can take is inversely proportional to your level of responsibilities (both personal and financial).
Your risk tolerance is a balancing act of risk versus responsibilities.
Attending A will have low risk tolerance than Attending B.
Life comes at you fast… and is shorter than you think:
Attending B may become Attending A faster than he/she thinks.
Only gamble with money you’re ok losing.
However, what you’re “ok losing” can change in the blink of an eye…
Agree? Disagree? Questions, Comments and Suggestions are welcome.
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