075 How to Avoid Risk in Investing

Hey there, real quick before we jump into the episode, listen, if your earnings treadmill hasn't set you free yet, running faster won't either. Listen, hustle without principles just going to burn you out. So here's what I want for you. I want you to join me for my money machine experience live. It is three free trainings. Deep dive into how to escape the treadmill and build a money machine that actually works for you. All right, Grab your spot here by going to moneymachinelive.com and I'll see you in the free training. I want you to take as much risk as possible with your investments. Now, wait a second. I didn't say take every risk. I said take as much risk as possible. Because here's what we know. If you try to avoid all risk, then you're likely not going to find yourself at financial freedom, okay? But figuring out your risk is a delicate balance between three specific things. And if you get it wrong, you either fall way short of your financial freedom number or you could lose everything. So in this episode, we're going to talk about those three things and what it means to have a true understanding of your risk profile so you can make the right decisions for your circumstances, your situation, and find the right investments to move you towards financial freedom. Welcome to this episode of the Absolute Entrepreneur show and I'll see you in the episode.

This is the Affluent Entrepreneur show for entrepreneurs that want to operate at a high level and achieve financial liberation. I'm your host, Mel Abraham, and I'll be sharing with you what it takes to create success beyond wealth so you can have a richer, more fulfilling lifestyle. In this show, you'll learn how business and money intersect so you can scale your business, scale your money, and scale your life while creating a deeper impact and living with complete freedom. Because that's what it really means to be an affluent entrepreneur.

Hey there. Welcome to this episode of the Affluent Entrepreneur Show. I'm Mel Abraham, and in this episode, we're going to talk about risk. Look, if you're talking about investing, you're talking about money, you're talking about wealth creation. You can't have that conversation without talking about the four letter word risk. You know, now I get it. So many people are risk adverse. I don't want to. I don't want to risk my money. I don't want to risk. I don't want to risk. The problem is that you can't invest and not have risk. It all happens. It all is part of it. The question is, can you invest.

Without taking Undue risk. And here's the other side of that is the realization that the level of risk that you can take versus the level of risk that I can take is different. And even more so, the level of risk you can take today is different than the level of risk you can take in 10 years. It changes. It's this moving target. And what drives that target are three specific factors that I want to walk you through. It's called the risk profiling triad. You probably have heard the term risk tolerance and risk profile and that type of stuff. I want to break it down for you because I think there's three specific components that come into play and how you start to look at it becomes important. Especially, let's face it, the market's been a little bit gyrating lately. Up, down and all around. I mean, it's doing some crazy stuff. We've got volatility and uncertainty. We've got interest rates and inflation. We've got all kinds of things going on, people missing, earnings, giving different guidance. So there's risk out there. How much risk should you be taking? Well, hopefully this will give you a way for you to start to understand how to evaluate that. All right, so let's jump to the iPad. I'm going to walk you through the risk profiling triad. And the idea here is to understand first off the three elements that go into risk. And the first is this is understanding what your risk requirements are. A lot of people don't think about this, but your risk requirements are based on what your target is. If we look at basically two factors that come into play is understanding what risk is required for you to take to try and achieve the numbers that you want. But let's look at the other two factors first. So we'll get them all on the table first. And that is then understanding the risk tolerance.

And then understanding your risk capacity. So the three things that we need to balance here are risk requirements, your risk tolerance and your risk capacity. And it's where those interchange and intersect that you start to understand what investments might make sense for you and what investments don't. It's through that you start to understand the risk profile. Too often we, we hear people talking specific just about risk tolerance. Well, that's only one, one part of it. If I have a three legged stool and I only have one leg, guess what? The stool's falling down. Okay, So I need to understand the other two elements beyond risk tolerance, risk requirements and risk capacity. And understand that these factors will shift over time. They will shift based on circumstances they will shift. So it's not a one and done thing. It's something that you need to continually evaluate on an ongoing basis. Let's look at this now. Let's go a little deeper. Let's talk about what goes into risk requirements. The idea here is this. We stand at a point in time. I am here as of this date, a specific date, and I'm looking towards the future. And I need to define what my target is. Is, in other words, what we call it in the affluence blueprint is what's my affluence vision? What's that number? What's, what is it going to take to give me that financial freedom? If you're not used to the, the four stages on the, on the financial liberation journey, we'll make sure that we hook up that video on the path, the map to financial freedom for you at the end of here. So you'll, you'll understand that. But the point being is this.

The first step is to really start to understand where you want to go. What's the destination?

What's the destination? Is it a million dollars? 2 million? 10 million? 100 million? Is it 500,000? The number doesn't matter. It truly doesn't matter. And I no judgment. It doesn't matter to me. But the number sets a point.

A destination, a target.

And then the second piece of this to understand your risk requirements is time.

How much time to get to that number. Now I get it. You're going to say as soon as possible, Mel, I get it.

But realistically, do I have 20 years, 30 years? 40 years? 10 years? 5 years? That changes the risk requirements.

The bigger the number, the shorter the time frame, the more risk you might have, the risk requirements you might have to take. Now, it doesn't mean that you have the capacity and the tolerance to do it, but it gives you the understanding. Now what we're trying to do is really start to understand.

What that takes. So the first is to identify what that target number is. I also have a video that talks about your wealth target. I'll make sure that that's hooked up here also, so you get a chance to work through that. And now you start to understand the target and the date of the target, whatever that time frame is. If I know that I need a million dollars in 20 years, I want, I, that's my target. That means that I need to at least accumulate 50,000, you know, over the 20 years a year. That means I need to create wealth at that rate. That means I need a certain Rate of return. I need to take a certain amount of risk to create that. By the time I hit 20 years risk requirements, it says, is what is it going to take for me to hit my target number in the time that I want to have the financial freedom that I desire? Okay, that leads me to, then to go to risk tolerance. Risk tolerance is more about psychology and emotion. Okay? It is, what can I tolerate? There are people out there that have a, you know, it's like I have a high threshold for pain. In fact, the surgeons, when they, when they found out that I had a 7 1/2 centimeter tumor in my, in my bladder, they were, they were asking me this, this whole thing of, of, hey, do you not have pain? I go, I got a high tolerance pain. I don't know. I, you know, so we all have different tolerance levels. It's the emotional psychological level. If you turn around and look at it and say, if I had an investment that went down 20% and I'm ready to run for the hills, I'm freaking out. My tolerance is different than someone that says, yeah, it's no big deal. It's an emotional, psychological kind of element. Now what causes your ability to understand your tolerance is one, understanding your, your emotions and your, your mindset around investing and risk. Okay, what can I physically, emotionally, psychologically tolerate? And what can help is understanding. So the second element is your understanding. What do I mean by that? Right now, if we look at the market, the market's doing all kinds of things. It's going up, it's going down, it's gyrating all, all over the place. If I'm so ultra focused on the decline that it's raising my stress, it's raising my emotions, it's putting me in a bad mood, I'm not good to people because of it. If my emotions are swinging with the market, I don't have a high tolerance, okay? But when I increase my understanding of the market.

Then I'm more apt to go, oh, this is expected. The market goes up, the market goes down. And when the market goes down, I might be able to buy more on sale and it will go back up. If you look at the history of the market, even though there's ups and downs over time, the trajectory is an upward trajectory. The problem is when we put tunnel vision on, say, oh my God, the market just dropped a thousand points today and you freak out and you think it's Armageddon. It went down a thousand points today, but over time it's a blip.

It'S a dot on a line. And the more that we understand investing, the more we understand money, the more we understand it, the higher our tolerance could be because it doesn't lift our emotions, it doesn't impact our psychology. So risk tolerance is really about the psychology around it and building it from that perspective. And then we get to risk capacity. Risk capacity is really about two things, your portfolio and your resources. In other words, what is the actual capacity for you to sustain a loss? What is the actual capacity for you to move forward if there is a decline? And the way this works is it comes down to your portfolio, your asset allocation, your asset diversification, and your resources. And what I mean by resources, I mean your liquidity, and I mean your income and in some ways your time. But if I know that I have, I'm generating income, Sam, generating a hundred, $200,000 a year and the market drops. And I know that I'm not, I don't need the money for 10 years. I've got over 10 years. If I'm generating $200,000 a year, there's $2 million more in income that's going to be coming in. Yeah, I'm spending some of it for lifestyle, but my resources are higher. If I'm retired, though.

And I'm on fixed income and I'm not making income, my resources are lower, which means that my capacity to take on risk is lower. So my portfolio has to be designed in a way that I'm not impacted by risk at a great level. So we have to balance the requirements with the tolerance, with the capacity which starts to be dictated by the timing of when you want to build the wealth. Number with respect to the requirements, the psychology and emotions around your ability to carry the risk emotionally and the nature of your ability to in actuality carry the risk and recover from financially. So you've got something that is emotional, you've got something that is future driven, and you've got something.

That is driven by strategy. Okay? When we have these things in place, when you have the proper risk requirements coupled with the proper risk tolerance, you will become knowledgeable. When you understand where you're going, when you need to get there, and how you feel about this, the emotion and the psychology, you're aware of it. When they turn around and tell me, mel, this is going to be painful, I'm now aware of it. I prepare myself to tolerate it. When you have the right risk tolerance and the right risk capacity and the right risk requirements, you see that it's feasible. Here's what I mean. By that I see my targets, I see my time, I look at my portfolio, I look at my resources and I see that I actually can make it so it's feasible. And then when you have the right tolerance and the right capacity.

You can be comfortable because now I know that I can sustain the risks. So when you do a full blown understanding of risk profile, it cannot be done without understanding your risk requirements coupled with the risk tolerance and your risk capacity. And these items will change. They're going to change based on your age, they're going to change based on your life circumstances, they're going to change based on your wealth. I might have a big net worth, which means that I have a capacity to take on.

Risk because I could recover, I got, if I lose the money, okay, big deal. I, I still have a lot more, okay.

But I might not have the tolerance for it. Not because I, I can't, it's because I choose not to. I don't need to take on risk. And I'm at a stage in our life where I'm kind of going, Look, I'm 60 years old, going to be 61.

We're at a place that we don't have to worry about it. So why would I take on an inordinate amount of risk? So my tolerance level is low. Even though my capacity might be high.

I know what my target is, I know what my time is. I got my requirements in place, I'm not going to play that game. But know that the 20 year old me had a different risk tolerance, a different risk requirement and a different risk capacity. The 40 year old me had a different one, the 60 year old me has a different one. It's the same with you when you have children, when you have children going to college, all those things will go into affecting these things. And this is why this becomes a moving target that you need to revisit probably every five years or so or when life changes. Okay, so you have kids or you kids, you're now empty nesters or you know, retirement, all those things. You want to revisit it on regular, on a semi regular basis just to make sure that you're on track so you're not in too risky a portfolio based on your requirements, your tolerance and your capacity or you're in not too conservative or portfolio based on your requirements, your tolerance and capacity. I hope this is making sense. So here's how this plays out because then you start to look at.

A couple things that you hear all the time, asset allocation and diversification. Because that's how we start to moderate the risk we're going to take on by deciding how we're going to allocate our investments and how we're going to diversify those investments. But the challenge is some people try to use allocation diversification synonymously, and I look at them differently. Asset allocation is like deciding.

The type of car you want. I want to buy an suv. Okay, so now I have an suv. Now the question is, what are the features? That's diversification. What are the features? So let me just show you how this might play out in, in real time. So what happens is that you're going to need to do an asset allocation. Now these are dependent upon your.

Risk requirements, your risk tolerance and your risk capacity. And so I'm going to allocate my assets, my investing to. And these are, there's no, this is arbitrary. So don't look at this and go, ow, that's like 25%. That's, it doesn't matter. So I want to allocate a portion of my, my investing to stocks, probably index funds, ETFs, equities. I'll have some in cash. I'll have some real estate. I'll get some alternative investments, things like real estate investment trusts or other types of alternative investments. But that's, that's asset allocation. You know, saying, what are the different types of assets I want to be into? Because that reduces risk in there. I might, I might have something that's correlated with the market, something that's not. But then say I'm looking at the stocks and equity inside the stocks and equity. Now you got to say, what stocks and equity? That's diversification. It looks like this.

So now if I know that I have stocks and equity, this is my allocation.

Then I look at the diversification and say, okay, if I'm going to have X dollars, I don't know, call it a hundred thousand dollars in stocks and equity. How do I want to break it down? And this further reduces or impacts your risk? Oh, I'm going to put a portion in aggressive growth. I might have some in international, I might have some in growth, I might have some in income assets and some in value. So these are all different asset classes, asset types.

For diversification. And you're, you know, if you're with a good planner, they're going to be doing this for you. So you start to understand what does it take to do this. But this is allocation, this is diversification.

Don't mind my spelling. So what you're doing is just breaking it down. In a way that says, look, here's the different assets that I want to be in, and once I'm in those assets, you can do the same. With real estate, this could be single family homes, apartments, REITs, although they may be over on alternatives and commercial. And you might have an, a diversification of the portfolio here. And with real estate, the diversification might be geography. So realize that there's layers to your risk that allow you to start to reduce the impact on the risk that you're taking on. So the point of this whole session is for you to look at how much risk is appropriate for you based on your requirements, based on your tolerance, and based on your capacity, and to then look at how you can design, and you do this with a professional that understands it and help design a portfolio that takes in consideration the proper allocation of assets and, and then within those allocations, the proper diversification of those assets to get the maximum returns for the minimum risk you need to take on that hits your target and your timeline. Okay, It's a much more complicated question than simply how much risk can you tolerate? And I hope you see that now. But when you answer it, you can make more informed decisions, because remember, when you do that, you're knowledgeable, you see it's feasible, and you're comfortable. And that's what I want you to be. I want you to be able to be aware. I want you to be conscious. I want you to be intentional with your financial decisions. And by understanding your requirements, tolerance and capacity, you have the ability to make effective, more effective decisions no matter what the market's doing, no matter what your circumstances are. And my guess is that you're all going to need some guidance to do this, which is totally fine. You're going to want to get with the right financial professionals to make that happen. But this is the steps that you need to go through to really understand it. And if they're only talking about tolerance and they're not talking about requirements and capacity.

I'd be a little careful. All right? Because I want you to be safe. My job is, is really this. I believe that everyone, you know, financial freedom is a birthright. We just gotta go claim it. But I want to keep you safe on the journey. I want to give you the pathway to dream. I want you to know what it takes to do. I got no investments to sell you. Okay, that's fine. I want to sell you on your dreams. This is possible for you. Let's just do it right? Let's give you the information, let's give you the tools, let's give you the tactics, let's give you the strategies so you can go make it happen. So you can have a new financial destiny. So you can get behind the movements, the missions and everything that you're trying to create. So you can create the legacy for you, your family, your kids, your grandkids. So you can be supremely generous with your wealth, your time and your being. All right, I hope that this helps. I hope this gives you some perspective as you start to look at investments and what's going on in the market and what you should be looking at. And if you've got questions or anything, please, please, please reach out to me. If you want to send me a voice question, go to askmailnow.com we'll see what we can do to help you to have a safe, sane conversation around money, investing, wealth, business and success. Let's make it happen together. Let's, let's enjoy the journey, too, until we get a chance to see each other. Another episode. As always, always, always strive to live a life that outlives you. Cheers. Bye.

Thank you for listening to the affluent entrepreneur show with me, your host, Mel Abrahamic. If you want to achieve financial liberation to create an affluent lifestyle, join me in the affluent entrepreneur Facebook group. Now, like going to melabraham.com forward/group and I'll see you there.

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