Finance Analogies: Spread Your Risk

A short analogy reminding the reader that we should apply prudent investment strategies to our lives more generally: 300 words.

Here’s my third attempt to find crossover between my former career in finance and my new career as a psychologist…

The idea of not putting all your eggs in one basket is fairly well accepted. You spread your risk, putting a few eggs in a few baskets. You might drop one or two baskets but probably not the lot, thereby averting disaster. Following this principle, financial advisers will suggest that their clients invest in a portfolio of investments, rather than betting their life savings on just one or two.

We don’t always apply this principle more generally across our life though. We invest time, effort and emotions in all aspects of our lives, and to spread our risk in life makes sense as an investment strategy. How many people dedicate themselves wholly to their careers, see only their immediate family, or perhaps spend all of their spare time at the gym. These situations are great so long as nothing goes wrong. But consider the career oriented person who’s made redundant, or the person who unexpectedly gets divorced and realises they don’t have friends anymore, or the gym junky who develops a chronic injury, and can no longer get their fix of exercise. Each of these people will lose a significant source of self-esteem, comfort and coping overnight, and will have little else to turn to.

We can be dedicated to our spouse and family, but also spare some time for friends. We can be ambitious in our career whilst remembering that it’s not the only thing that makes us valuable. And we can benefit from a regular exercise routine without obsessing over it.

So, try taking an inventory of the investments in your life, and see whether you could benefit from diversifying a little. It will take more effort, but even if all of your existing investments continue to pay a return, you just never know how rewarding other opportunities might be.

Finance Analogies: Don’t Over-insure Yourself

A finance metaphor illustrating the cost of trying to eliminate all risk from our lives, and presenting an alternative to this: 480 words.

Here’s another go at finding commonality between my former career in finance and my work as a psychologist.

When we purchase insurance we incur a small cost upfront to eliminate the risk of greater losses later on. That all sounds lovely, only insurance companies earn a profit margin on these transactions, ensuring that in the long run they will earn more in insurance premiums than they will pay out to cover people’s losses. In fact, over a lifetime a large majority of us will claim less in insurance than we will pay out in premiums. So why take out insurance at all? Well, one reason would be if there is a plausible risk of a major loss that you could not expect to cover, such as your house burning down. But aside from these situations, the benefits from insurance are mostly psychological – specifically, we gain peace of mind.

But another way to achieve peace of mind in these circumstances is to take a long term view of risk. If we can accept that over a lifetime there is only a very small chance of ever claiming enough on our insurance to justify it, then we could do away with insurance on all but those big ticket items like a house. Sure, we will have a few occasions when we do have to replace an item that we didn’t insure, but the money we save will most probably more than offset this. But many of us struggle to take this long term view. Our emotions are built to focus on more immediate concerns, and if I’m concerned about my new refrigerator breaking down unexpectedly then I’ll buy that extended insurance to allay my concerns. Consequently many of us over-insure our lives.

But this tendency to over-insure doesn’t only apply to financial transactions. We do the same thing if we always carry an umbrella as insurance against it raining, or when we put in unpaid overtime to prepare for almost every possible question at the next work meeting, or when we take a swath of vitamins each day just in case we pick up a particularly virulent flu virus. The cost of carrying that umbrella may be small, but add that up over a lifetime and then compare it to the odd occasion when we’ll get wet, and it’s likely that we could benefit in the long run from leaving the brolly at home.

My examples may seem trivial, but the risk-averse people amongst us insure almost every aspect of their lives, and in doing so, weigh themselves down with the burden of all that insurance. If that is you, then try and take a long term view of the risks in your life, learning to accept the smaller risks that you can deal with should they eventuate, (and you can cope with a lot more than you think). Allow yourself a wry smile when you get caught in the odd rainstorm, but remember that you travel lighter nowadays.