Wealth Diamond and Risk
Generally speaking, each of the three Wealth Diamond segments has a different potential for risk.
Secure Assets can be considered as low-risk investments while the Cash-generating Assets are medium risk and the Speculative Assets as high risk.
This is however, not always true as risk is directly influenced by specialist knowledge and expertise. As Warren Buffet puts it, “Risk comes from not knowing what you are doing.” For example, an individual or group with specialist expertise can achieve exceptional returns with very low risk.
Knowing what you are doing is the best way to reduce risk.
I would like to introduce you to three of my best financial advisors, ROF, MOE and COF. They have taught me how to navigate the minefield of life with confidence as I pursue my goals.
ROF is Risk of Failure and is directly influenced by internal and external factors. Internal factors are things like Knowledge and Expertise while external factors are macro Political, Economic, Social and Technological (PEST) factors. For example, the ROF is higher for a novice (internal factor) gymnast on a balance-beam on a windy day (external factor) than for an experienced gymnast; the same external factors but different internal factors result in different ROF for the novice and master.
MOE is Margin of Error and refers to the factors that affect the probability of failure. For example, the Margin of Error is 'tighter' on a 5cm wide balance-beam than it is on a 10cm wide balance-beam.
COF is Consequence of Failure and is probably the most neglected risk consideration. For example, the consequences of falling off a balance beam one meter above the ground are relatively minor while falling from a balance beam a hundred meters above the ground would likely be catastrophic.
Here is a principle I taught my teenage children when going out to parties;
"Have fun but don't pay for it tomorrow!"
A quick discussion with ROF, MOE and COF is all it takes to clarify the risks of getting into a car with a drunk driver. And to back up my advice, I made sure that a safe option was always available to them, even if that meant me fetching them at 3am in the morning.
This principle applies equally well to life as it does to money; like watching out for the long-term cost of instant-gratification.
Age and Risk Tolerance.
The shape of the Wealth Diamond depends on two main factors, age and tolerance for risk. As a rule of thumb, one’s tolerance for risk reduces in direct proportion to one’s age.
In other words, the older we get, the less time we have to recover from setbacks and therefore need a higher proportion of our Wealth Diamond in Secure Assets. On the other hand, a young person with a higher tolerance for risk, may have significantly less in Secure Assets and more in Cash-generating and Speculative Assets.
To repeat Warren Buffett,
“Risk comes from not knowing what you are doing.”
While managing risk is a personal responsibility, it does not have to be a lonely journey. In fact, to minimise risk, investing should not be a solo-journey.
Like all good expeditions, investing should be a team effort, a team of trusted partners; an A-Team in which each person plays an important role in the success of the whole.
Together Everyone Achieves More
See more about this in Wealth Diamond and Investment Management.