Blog | Personal Finance

Risk Management for 2023

When it comes to being an investor, being “conservative” can leave you unsuccessful. Financial intelligence means knowing which risks to take, and which to avoid

Summary

• There is a correlation between financial intelligence and investment risk

• Being risk averse minimizes the opportunities to become a successful investor

• The key to being successful is to take smart risks - not to be foolhardy

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A common question for investors is: “what level of risk am I comfortable with?”

When it comes to working with financial planners or stockbrokers, they’ll always want to know about your risk tolerance — aka, if you’re conservative or aggressive — when discussing your investments. Unfortunately, they don’t even realize that’s the wrong question to ask.

Risk management is correlated to financial intelligence

While discussing investments, many people may identify themselves as being “conservative” when looking at investment opportunities. In reality, this word often gets confused with “uneducated.”

Which means the question that financial planners should be asking is “Are you educated or uneducated when it comes to your investments?”

Saying you are “conservative” is just a risk management excuse that could easily be translated to, “I’m uneducated, scared, don’t know what to do, and don’t want to take the time to learn.”

Think about it: If you tell your financial planners you are a conservative investor, they know right away that you are uneducated about investments. It’s a dead giveaway that allows those with a dubious moral compass to pray on your weakness and sell you whatever they want! Sadly, thousands of uneducated “investors” hand their money over to financial planners every year. But who’s to say they really have your best interests at heart?

Of course, that’s only a consideration if you’re working with an actual human financial planner. The total assets under robo management— that means a computer is using automated algorithms to build and manage a client’s investment portfolio instead of a living, breathing human who calls themselves an expert in this field — grew 15% in 2018 to $257 billion. As of this year, it has exceeded $1 trillion. Technology is rapidly changing the financial advisor space, and not necessarily in a good way.

You see, the conventional wisdom of most financial planners is: “The higher the return, the higher the risk.” But that’s not really true. What’s really true is: The lower your financial intelligence, the higher your risk; and the higher your financial intelligence, the lower the risk. And that’s why it’s crucial to improve your financial intelligence — it’s the only way to truly learn how to reduce investment risk.

Another way to assess investment risk

Many people are turned off by investment risk; they’re consumed with the idea that comfort and security is more valuable than the rewards that come from investing - because it’s risky.

They mistakenly think that investing is risky, when in reality it’s the investor who is risky. Consider this: An investment is just an investment, whether it’s a business, a property, a stock share, or a commodity. It’s you, the investor, who determines if a specific investment is a good or bad investment for you.

If you’re wondering how to reduce investment risk, start by knowing this: Not every investment you choose will be a good investment, as no investor has a 100% track record of picking winners. Yet, the more knowledge you have, the better your odds for reducing investment risk.

Plus, if you’ve done your research, you will know why you are making a particular investment and what is happening with the money you invest. If you just turn your money over to a financial planner to invest for you, you lose control, and when you lose control, your risk factor goes up significantly.

Here’s another way to examine this theory: Is a car going 25 miles per hour driven by an experienced driver risky? Probably not. Take the same car and the same speed driven by a drunk driver and that same car becomes a weapon. It’s not the car; it’s the driver. It’s not the investment; it’s the investor.

Investment risk and the CASHFLOW Quadrant

Robert Kiyosaki’s poor dad, his natural father, felt that instead of risky investing, smart people got a good job, and saved their money.

His rich dad, his best friend’s father, on the other hand, felt that his poor dad’s way of thinking was the risky one. He aspired to own his own business, and to invest his money rather than to save it.

Their opposing views on the world are best explained by the CASHFLOW Quadrant, or ESBI.

Each quadrant of the ESBI represents a certain type of person and mindset.

E stands for Employee. An employee values job security, benefits, and a steady paycheck. To attain this, he sells his time to an employer. He does not like risk, nor does he understand how money works. His education is traditional and prepares him to be a good employee.

S stands for Self-Employed or Small Business Owner. An S values independence. He does not have a boss, and works for himself. He doesn’t have a job. Rather, he is the job. The problem for an S is that he cannot take time off. If he does, he stops making money.

B stands for Big Business. A big business owner doesn’t have a job, nor does she own one. Instead, she owns a system. Her mindset is how do I hire others to make money for me in the system I’ve built. She has financial freedom because she is able to stop working and still make money.

I stands for Investor. An investor believes that money can be used to make more money. She is adept at using debt, taxes, insurance, and more to make money passively through investments in assets. She sees the world as one of opportunity and abundance.

Investment risk on the right and left side of the CASHFLOW Quadrant

As you can tell, the ESBI is divided into two sides. E and S are on the left side, and B and I are on the right side.

Those on the left side are often uneducated about money, business, and investing, and they fear risk. It is, however, their lack of education that makes business and investing seem risky.

Those on the right side understand how money and investing work, and they see the world in a much different way. They believe that being an employee or self-employed is actually much riskier than owning a big business or investing because you lack three things: training, control, and knowledge.

Poor dad lived his life on the left side of the ESBI. Rich dad lived his life on the right side. Poor dad struggled all his life and always complained about his financial state. Rich dad grew his wealth each year, and like the game of Monopoly, he traded up his houses for hotels over time.

Redefining what risk means

Warren Buffett says of risk, “Risk is not knowing what you are doing.” Again, the key word here is “you,” not the investment.

Think of RISK as this:

Reckless

Investing

Sans

Knowledge

Tom Weissenborn, a successful stockbroker, offers these two rules when it comes to investing in stocks:

1. If you don’t understand how the company makes money, don’t invest in it.

2. If it looks too good to be true, then it probably is.

As you’ve learned, in the world of investing, there are no investments that are 100% guaranteed to be safe (free from losses), but there are things you can do to reduce investment risk and increase your chances of success:

1. Give yourself a financial education
2. Gain hands-on experience by actively investing (a small amount of) your money
3. Understand the investment and the return on the investment
4. Have control over your investments
5. Become your own financial advisor

All of us make mistakes when it comes to investing. And most people are busy with other things and do not want to deal with complicated numbers and investments. It’s so much easier to participate in your company’s 401K or hand your money over to someone else to invest for you.

Avoid these 3 investment risks

After a lifetime of studying the lives of both rich dad and poor dad, Robert learned the three key reasons why his poor dad really thought investing was risky - and why investment risk was a reality for him and others like him.

Investment risk #1: Lack of training

Take a look at our article about the three types of education: academic, professional, and financial.

Most people go to school to be trained on how to be an employee or self-employed through academic and professional education. School teaches us things like reading, writing, and arithmetic, all good things and useful for the work world. It teaches us how to execute on orders from our superiors and be where we’re told to be at the right time—the mindset of an employee.

Some people go on to higher education and train to be in high paid professions like being a doctor, lawyer, or accountant. But at the end of the day they are just high paid employees or self-employed. Few people who focus on academic or professional education make the leap from the left side of the CASHFLOW Quadrant to the right side.

Unfortunately, school doesn’t teach how money works, or how to have it work for you. It doesn’t teach you the skills necessary to become a business owner or an investor. Those are skills that you must seek out and teach yourself, starting with the four foundations of financial literacy.

As a result, most people simply lack the training necessary to know how to mitigate investment risk. And without training and knowledge, investing is risky.

Thankfully, Rich Dad exists to help you increase your financial intelligence through our books and games, classes, and coaching.

Investment risk #2: Lack of control

During the last Great Recession, it’s likely that many people came to believe that investing was risky as they watched their stock portfolios tumble. And again, most recently, it’s likely many people were decimated during the global coronavirus pandemic.

The reality is that most people don’t have a true investment plan.

Instead, they work hard and hand over their money to an “expert” who invests it in some mutual funds, stocks, and bonds. The problem is that these types of investments increase investment risk. You have no control. You are at the mercy of the markets and managers. That is a position of risk.

Successful investors, on the other hand, strive for as much control as possible in order to minimize investment risk. In fact, we’ve provided an article about the 10 key investor controls a sophisticated investor must have in order to be successful.

That is why you need to invest in businesses where you have decision-making power, and it’s why real estate is a great investment option (because it can lock in cash flow for extended periods of time). In both cases, the investor has a lot of control over what happens with said investment.

Investment risk #3: Lack of knowledge

Most of us know intuitively that if you want a real deal, you need to be on the inside. You often hear someone say, “I have a friend in the business.” It doesn’t matter what the business is. It could be to buy a car, tickets to a play, or a new dress. We all know that “on the inside” is where the deals are made.

The investment world is no different. As Gordon Gekko, the villainous character played by Michael Douglas in the movie Wall Street, said, “If you’re not on the inside, you’re outside.”

Employees and self-employed people generally invest from the outside, where the investment risk is high. They have limited knowledge of what they are actually investing in.

Those who operate as business owners and professional investors have detailed knowledge of what’s going on inside of their business or their investments. They are the drivers of the business or investment, and because they have the insider knowledge that makes their investment risk much smaller.

How can you minimize your investment risk?

The first step to minimizing your investment risk is to actively work to change your mindset to move from the left side of the CASHFLOW Quadrant to the right side.

That is not to say that you can’t invest on the left side, but it is much harder as there are many forces acting against you, mainly it is very hard to have any control, even if you have training and knowledge. Also, because those on the left side sell their time, they rarely have the availability needed to manage their investments the way someone on the right side does.

Moving to the right side of the quadrant means getting the right training and knowledge, and putting it to use so that you can be in a position of control. This means daily increasing your financial IQ through things like coaching and seminars. Ultimately, however, you must take that knowledge and put it to use. Nothing teaches us better than trying, failing, and trying again.

Moving from a position of risk to a position of security when it comes to investing takes financial education and practice. Take an honest look at your investment position, and take the steps necessary to gain training, control, and knowledge. It will be one of the wisest decisions you can make.