5 Reasons You Must Take Risk To Achieve Complete Financial Independence
How The Risk-Reward Paradigm Benefits Long-Term Thinkers
Chief Business Development Officer, Founder
Cory Baer is the Chief Business Development Officer for Strait & Sound. In this role, he fulfills a dual mission. First, he serves clients by ensuring that they have the best possible financial plan to achieve their long-term goals, particularly complete financial independence. Second, he also serves as an ambassador of the Strait & Sound brand by introducing the firm to the larger community and select strategic partners.
My colleague Todd Sixt wrote a couple of great articles about achieving complete financial independence. In this article, I want to expand on an idea Todd presented that I believe will have a major impact on this goal—risk. My thesis is simple. Most people in this country will have to take risk to achieve complete financial independence. However, this is a topic that makes a lot of people uncomfortable. I totally understand that. Risk makes me uncomfortable too. None of us want to lose our wealth.
After more than a decade of serving clients in the financial services industry, here is what I’ve learned. Not all risks are alike. There are some risks I believe you should take and others you should avoid. Yet, after working with hundreds of clients, my observation is that most people are not taking enough of the right kinds of risk and sometimes take the wrong risks. Here are five guiding principles about risk that can serve you well as you work toward achieving complete financial independence.
What Is Complete Financial Independence?
Just so we’re on the same page, I want to clarify how we think of complete financial independence at Strait & Sound. This is about achieving a certain position in life where:
- Your lifestyle is comfortable, but reasonable and disciplined.
- Your cash in-flows are substantially more than your cash out-flows monthly and annually.
- Your income sources and assets are diversified so that losses in any one area do not force you to alter your lifestyle: social security, cash, investments, pensions, real estate, etc.
- Your income sources will continue to produce more than you need for the rest of your life.
- You may or may not be working for money, depending on what you want to do with your time.
- You have the right set of advisors around you to give you great counsel when you approach forks in the road.
- If necessary, and especially as you and your loved ones age, you have people you trust around you to help manage your financial affairs.
Given this definition, the question then becomes—what role does risk play in achieving this?
Five Guiding Principles For Thinking About Risk
I want to say this for the record. Not everyone needs to take financial risk and some people shouldn’t take it at all. If you are struggling to put food on the table, food is more important than taking risk in the stock market. If you’re struggling to pay for housing, I wouldn’t advise you to take risk in the markets. In other words, I don’t think people should risk money they need to live on.
However, there are literally millions of families in this country who do have monthly discretionary income. Yet, only a small portion of these families will ever achieve complete financial independence, the way I’ve described it above. There are multiple reasons why this won’t happen, usually because people don’t follow a long-term financial plan over many years.
But there is also another culprit—making the wrong moves with risk. Most people, in my experience, don’t take enough of the right risks. Others take inadvisable risks. I find that risk often puts people in a flummox, where they seem to struggle to think clearly and act with confidence. To help address this, I’d like to put forward five guiding principles about how to address risk in the healthiest way possible.
- No risk equals no reward.
- Time-in-market beats timing-the-market.
- Smart risks are your friend and dumb risks your enemy.
- Long-term risks are better than short-term risks.
- Risks are a team sport not a solo act.
No Risk Equals No Reward
In general, I believe risk is our friend, not our enemy. I tend to think about risk like electricity. If you use it well, it can light and warm your house and bring you endless hours of entertainment and connections to loved ones. Or it can burn your house down. The difference between these two outcomes—a comfortable and well-lit home versus charred ruins—depends on how you use electricity. But can you honestly imagine living in a home without electricity and modern conveniences?
Just as we have learned to harness the power of electricity to improve our lives over the last 150 years or so, we’ve also learned a lot about risk, particularly investment risk. For instance, did you know that the markets, on average, have only been in a bear cycle for 22 months before coming out of it? Think about that for a moment: 22 months. In the scope of a long-term financial plan, that’s barely a blip on the radar screen.
And yet, bear markets have such a strong psychological impact on people, causing some people to become risk-averse. When the markets dip, so many people are inclined to engage in the behavior that is exactly the opposite of what works: buy-low—sell-high. When people sell-low in a bear market, they lock in their losses. They remove any possibility of a recovery.
For example, Apple stock in the 1980s cost about $2,200 for 100 shares. If someone held those shares until today, they would be worth around $1.1 million. But along the way, Apple’s stock was up and down and so were the markets. If someone exits the markets simply because things go down, they miss the opportunity to go up. I have come to believe that being risk-averse often costs you more than being risk-tolerant.