Investing 
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Are your genes influencing your investing decisions?

Is your DNA influencing your finances?We hear a lot about money personalities, and how they influence our financial decisions. But why do you have the money personality that shows through in your life? What’s behind it? The answer might be in your genes.

When it comes to the decisions you make with regard to financial risk, research shows that your genetic makeup can be a big influence.

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 Banking 
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How To Prepare for Online Bank Access Failures

One of the biggest concerns people have about online banks is that, for many of them, you can only access them through the web. With these simple techniques, you can mitigate the severity of that risk and take advantage of their high yields without putting yourself in a bad situation.

Recent Online Bank Access Problems

First, is this even a valid concern? I think so.

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 Personal Finance 
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Cavalcade of Risk #54

If only managing risk were as easy as playing a game, we’d all be experts and life would be safe and predictable. Unfortunately, risk comes in all shapes, colors and sizes, so we must always be diligent in our management of it. But, if we ever need a diversion, the Parker Brothers’ classic is always there. :)

Health/Medical

Investing

Not Investing (Real Estate, Insurance, etc.)

  • NtJS presents Some Advice To a Friend about a recent business proposal he received. “My friend had been hit with a business proposal by some colleagues. It didn’t sound like a terrible deal – no pyramids, or get rich quick deals. The ones who had proposed it had a well thought out plan. They had run the proposal past lawyers and industry professionals and had gotten the thumbs up from everyone. The real details aren’t important here, but there were a couple that set off the alarms in my head.”
  • Henry Stern, LUTCF, CBC presents Biting the Hand That Feeds (An Update) posted at InsureBlog. “Just last week, we learned that the MVNHS© had successfully killed off another beneficiary (citizen) via the clever method of denying that “free health care” that we’ve heard so much about. Never fear though, dear Brits…”
  • Dan Melson presents Why You Want The Lender to Assume Pricing Risk posted at Searchlight Crusade. “By forcing the lender to assume pricing risk, you are far more likely to end up with a better loan out of the process, because they have to tell you about the real costs and the real rate that they have reason to believe you will qualify for. If they don’t, the difference comes out of their pocket, not yours, whereas in any other pricing scheme, who do you think is going to get stuck for the difference? For this reason, I’ll recommend any guarantee that forces the lender to assume pricing risk over any loan quote that does not.”
  • Jason Shafrin presents Mandatory Seat Belt laws posted at Healthcare Economist. It’s Jason’s contention that we shouldn’t have mandatory seat belt laws because it draws enforcement resources from other tasks, which I disagree. I think that if someone were to do a study, they’d find that police rarely stop drivers only because they are not wearing seat belts. It’s usually for something else (speeding, broken lights) and then an additional citation for the lack seat belt use.
  • Louise of Colorado Health Insurance Insider writes “What Drives Health Insurance Premiums.” Health care is a necessity. And the health care industry is very aware of that fact. If money is tight, you might forego buying a new car or going out to dinner. But if you’re on kidney dialysis, and taking a handful of medications with every meal, you don’t really have a choice about whether to continue your treatment when the budget is lean.
  • Over at the 3Gen blog, Jenna wonders of new grads run an increased risk of job burnout.
  • Blogging at ISACA Sacramento, M.P. Schmidt disses federal government efforts at IT risk management.

The next Cavalcade of Risk will be hosted by Colorado Health Insurance Insider on July 2nd, please get your entries in as soon as you can!


 Your Take 
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Your Take: What Are You Clueless About?

Risk!I’m clueless about a lot of things but the number one thing on my mind lately has been risk in investing. I don’t mean stock market investing or real estate investing, I meant the concept of investing and risk (specifically, determining and being paid for taking risk).

Most people associate investing with the stock market because that’s the easiest way to invest. The stock market is the perfect investment system in that your assets are pretty liquid and the barriers to entry are low. It’s absolutely free to open a brokerage account and trades are dirt cheap (cheapest is $0 a trade at Zecco, but that has gotten mixed reviews; second cheapest reputable brokerage is TradeKing). You can buy and sell stocks pretty easily as there is never a scramble to find interested parties, though the price you get may not be to your liking. You hope for good equity appreciation (increase in stock price) and perhaps take some cash flow along the way (dividends). The rate of return on the S&P has been around 10% for the last 80+ years.

Now take the second thing people associate with investing – real estate. In real estate, the assets aren’t as liquid (especially now!) and the barriers to entry are much higher. At best you have to come up with a downpayment and transaction costs (Realtor fees, lender fees) are high, fewer people get involved in real estate investing. (Over the next two weeks I’ll have four guest posts going over real estate written by Trisha Allen, a seasoned real estate investor, so if this is up your alley keep your ear to the grindstone) With real estate, again you hope for good equity appreciation (increase in home value) and perhaps some cash flow (rent) along the way. The rate of return on this has generally been about inflation (surprisingly) according to some experts (they could be wrong).

There are other means of investing (such as owning your own Rita’s Italian Ice!) but the gist is to put your hard earned money to work for you. However, how do you analyze risk?

Every risk analysis class I’ve taken, be in undergrad or for the MBA, has always explained the same thing. You take the severity of a bad event times the probability and that’s your risk. They never talk about how to guesstimate the severity or the probability, just that you multiply and some magic number comes out. Also, they never talk about how much of a payoff you should get for shouldering how much risk. Real estate seems riskier to me than the stock market (higher barriers, more money involved, more headache), yet the stock market has greater returns. One expects riskier investments to yield greater returns.

Anyway, that’s what I’m clueless about, how about you?

(Photo by Patrick Haney)


 Investing 
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Understanding Investment Risk Types

Risk is a word that gets thrown around often, especially when referring to the stock market. Experts talk of the dangers of investing in the market and the dangers of not investing in the market. They talk about how you need to take on an acceptable level of risk for your tolerance and how you need to mitigate your desire for fantastic returns by taking on a reasonable level of risk. Risk sounds so risky! So, what are all of these risks and how can you mitigate them? That’s what I sought to finally understand and this is what I learned.

There are a lot of fancy names for risk but the bottom line is that understanding them gives you a better chance are being able to mitigate their effects. You can’t fully reduce risk but through proper diversification, you can reduce their effects on your total portfolio so there isn’t one silver bullet that can take you down.

First, let’s talk about the differences between systematic and unsystematic risk. Systematic risk also known as undiversifiable risk refers to risk that affects an entire market or market category, such as market risk. Short of investing abroad or hedging your bets, you can’t get away from market risk. Unsystematic risk is also known as specific risk and refers to events that affect a small number of stocks, such as the risk of a strike or poor management decisions. You can reduce unsystematic risk by properly diversifying your holdings.

Market Risk

Market risk refers to the risk you take on as a result of investing in a particular market, in my case it would be the United States. Market risk refers to the idea that if the overall market falls, perhaps in response to Fed actions on interest rates, rising costs of oil, etc., then your investment may slide along with every other stock.

To mitigate market risk, you have to diversify your holdings such that you’re not entirely committed to one particular market. An easy example is to diversify your holdings through the purchase of ADRs or emerging/developing/international stocks. In mitigating domestic market risk, you introduce several other risks such as the foreign country’s market risk (known as country risk) and currency risk (impact of the change in exchange rate between the dollar and the foreign currency). However, since you’re diversified, the effect of each of those risks is lowered.

Inflation Risk

Inflation risk refers to the risk you take by not investing your money, stock market brokers love this risk :) . Inflation, which most rules of thumb peg at around 3-4% a year, erodes the purchasing power of your money every single year. If you don’t get 3-4% annual returns on your dollar, you’re effectively losing that money each and every year.

You mitigate inflation risk by investing your funds, but this naturally introduces a whole hosts of other risks. The only difference here is that inflation risk is a near certainty – inflation doesn’t roll the dice to see if she’ll erode your money this year, she always takes it. :)

Manager Risk

Manager risk, or management risk, refers specifically to the risk that your mutual fund, or the company you’ve invested in, will suffer as a result of ineffective, poor, or under-performing management. It essentially points to the fact that the company or fund may be sound but the management made bad decisions that cause the stock price or fund price to suffer.

This is difficult to mitigate outside of diversifying your assets because you often won’t see anything that could clue you in. Oftentimes, managers simply make bad decisions or bad bets and it’s nothing intentional. You don’t see many Enrons and, even if you did, there are no obvious signals warning you that something is foul. Simply do your research and be confident that the manager of the fund you’re interested in has a long, strong and solid history of performance.

A close relative of manager risk is active risk, which refers to the risk associated with a manager of a mutual fund trying to beat his or her benchmark. Active refers to actively trading, or active mutual fund (vs. passive index mutual fund), and it’s been shown that the more active the fund, the more divergent it will be with respect to returns vs. its benchmark. Sometimes you beat the benchmark, sometimes you don’t, that’s active risk.

All Other Risks

There are plenty of other risks out there with fancy names like Political Risk (effect of political instability or changes in a foreign country), Liquidity Risk (lack of demand for your investment might make it difficult to sell), Reinvestment Risk (you can’t reinvest your funds at the same rate, or at all), etc. but I felt that those big ones were the only ones worth focusing on at this point. There are a lot of risk terms out there that can get as specific or as general as you could ever possibly want, but understanding market, inflation, and manager risk is usually sufficient for most purposes.


 Cars 
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comments

Take Risks, Bear Consequences, That’s Life

It was a pleasure meeting JD this weekend and so I was concerned when I heard that he and his wife were in a car accident after we had parted ways. It appears that all is okay for JD, both physically and financially, which is great news; but all was not okay for the other driver.

If you’ve met JD, or read his blog, you know he’s a really nice guy. He’s very cognizant of others and the impact of his decision on others, so it’s not surprising to read his post about how he feels bad that this event may have tragic consequences for the other driver. Unfortunately, we all take risks in our lives and have the unfortunate burden of bearing the consequences should they occur. If the other driver didn’t have a driver’s license, he shouldn’t have been driving because he hadn’t demonstrated the minimum requirements (he could’ve used a bicycle, rode mass transit, etc.). If the other driver was in the United States illegally, unfortunately he took the risk to enter illegally rather than legally and now would have to face the consequences of his decisions. JD can’t let the decisions others make affect what he should do for himself and his family.

Let’s say that he did what his heart wanted, which was bear the financial brunt of the accident where he was entirely not at fault. What happens if he or his wife develops neck or back problems down the road? Since insurance was never notified, he alone bears the medical cost. If it were his car and it developed significant problems as a result of the accident, he alone bears the cost. He can’t “go back in time” and report the accident. While selfish, the future is a very long time and he has to think about the “total potential cost” of the accident and not just the cost of repairs. I think he did the right, and only, thing.

On the topic of accidents, taking risks and facing consequences, I have a similar unfortunately story (luckily we were witnesses and not participants).

One night my wife and I were driving home when we saw an accident at an intersection with a flashing red and flashing yellow light. This was one of those traffic lights that went from Red/Yellow/Green in the day, to flashing yellow and flashing red at night. The rules are that those who see flashing red treat it as a stop sign and those who see flashing yellow don’t need to stop but should proceed with caution. In this particular accident, the car with the flashing red didn’t stop and hit the car with the flashing yellow. This was a relatively slow accident but the damage to the flashing yellow car (not at fault) was pretty bad, it was undrivable; and the damage to the flashing red car (at fault) was relatively minor.

To make the drama worse, the driver of the at-fault car jumped out of the car and ran into the night! A few minutes later someone else returned (allegedly the same guy), but we were pretty sure he was different because there were two witnesses vehicles and we both thought the same thing. We thought the driver didn’t have a license or didn’t have insurance so he bolted, leaving his pregnant companion (wife? girlfriend?), to get a friend to take his place. Anyway, the true sadness in this story was the fact that the police discovered the driver of the not-at-fault car, who was driving with someone who appeared to be his son, was found to be above the alcohol limit and he was arrested. The other car drove away with a citation.

The man did not appear intoxicated, not that appearances are a good indicator, but ultimately did nothing wrong in that particular accident. However, he decided to risk driving home while he was legally intoxicated and now he had to face the consequences. Would the cops not have arrested him because he was with his son and he did nothing wrong in the accident? No. They couldn’t and now the guy was in handcuffs, sitting on the curb, with his son sitting next to him. It was a sad sight to see but we must all bear the consequences of our actions.


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