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Why Risk “Tolerance” is Ridiculous

By Garrett Gunderson

If you’ve ever worked with a traditional financial advisor, you’ve probably taken a risk profile to determine how much risk you can tolerate.

The idea, of course, is that the higher returns you want to enjoy, the more willing you must be to take on risk.

This is backwards and illogical, yet so few people are able to see it for what it is. Does it make any sense that in order to increase our chance of winning we must also increase our chance of losing?

The way to prosper is to decrease your risk as much as possible. Because of the prevalence of advice from retirement planners, most people balk at this idea because they’ve been trained to equate low risk investments with low returns (i.e. Certificates of Deposits, Money Market accounts, bonds, etc.).

However, there are numerous risk mitigation strategies that can dramatically increase your investment returns. The more certain you can make any investment, the greater chance you have of profiting.

Risk-taking is a strategy for people in scarcity who rely upon simple luck for success.

The fact is that financial institutions have a vested interest in you believing this. Why? Because they are using it as a technique to get you to take on their risk! It’s a risk transference, insurance strategy for them.

What’s even more interesting is that the same institutions do exactly the opposite with their money than what they teach you to do with your money. They’re not taking risks; they’re getting end consumers to take on their risks for them.

For example, if you apply for a mortgage, some ways that the bank will mitigate their risks are to do the following:

  • Check your credit.
  • Secure their investments with collateral.
  • Control the down payment.
  • Control the interest rate.
  • Control the payment.
  • Control the time period for each investment.
  • Impose pre-payment penalties.
  • Verify your work history and income.
  • Cover all of their investments with insurance (and interestingly enough, they have you buy it).
  • Have an exit strategy that allows them to be profitable, or to at least return their initial capital, in almost any scenario.
  • Collateralize their investment (see below) so that if you default on the loan, they can foreclose on the house and resell it.
  • Transfer their risks to the borrower in any way possible.

Decrease Your Financial Risk with Collateral

When a person “invests” in a mutual fund, what security do they have if the mutual fund fails to produce a positive return? Of course the answer is that they have no security at all.

The mutual fund does not guarantee any results, and if they lose money, they have no recourse to gain it back.

Wise investors seek collateral. Collateral within a financial context is used to indicate assets that secure a payment obligation.

For example, in the case of a mortgage, the house serves as the collateral for the mortgage loan. This way, the bank is secured against the default risk of the borrower not being able to meet the interest payments. In case of default, the bank can sell the house and get its money (or at least a part of it) back.

Almost every product sold by retirement planners cannot be collateralized in any way.

Every investment you make should have some form of collateral. Collateral can come in many forms including real estate, cars, jewelry, percentages of ownership in companies, percentages of sales agreements, legal documents, ownership in intellectual property, etc.

Having said this, it must be stressed that securing collateral is but one risk mitigation technique, and not something to be excited about or depend on. It’s one of the last things to consider when it comes to making an investment.

The primary focus of your investment strategies are whether or not the people with whom you are dealing can be trusted, and if it is a solid value proposition.

In other words, don’t make investments simply because they’re collateralized, and you’re hoping that the person defaults so that you can take the asset.

Make investments with people of integrity and that create real value for others so that you’ll never have to exercise foreclosure proceedings to secure the collateral involved.

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Garrett Gunderson is an entrepreneur, financial coach, the founder of Freedom FastTrack, and the primary author of the New York Times bestseller Killing Sacred Cows: Overcoming the Financial Myths that are Destroying Your Prosperity.

Garrett loves inspiring others to turn their potential into production. He has dedicated his life to living and teaching a unique concept known as Soul Purpose that reveals how anyone can live a more prosperous and rewarding life.

As a finance and business productivity coach, Garrett instructs both large and small groups of business owners and financial service professionals nationwide.

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Why Risk “Tolerance” is Ridiculous