The last two years have been a stark reminder of the importance of having a financial safety net. Life doesn’t always go to plan and when things turn to custard, it’s important to have resources to fall back on. But that doesn’t mean you need to be conservative or avoid taking risk. Life is not meant to be boring. It is for living to the full, making the most of opportunities and taking a few risks along the way. Of course, risk is not for everybody, but it’s hard to avoid it completely. On the other hand, some people choose to live life on the edge, putting themselves at financial risk. Risk takers are people who:
- Spend all their income
- Live from pay-day to pay-day
- Borrow heavily either to spend or invest
- Set up new businesses
- Gamble or speculate
Most people fit into at least one of these categories at some point during their lifetime. If you are a risk taker, it is important to be aware of the risk you are taking and to protect yourself before things go wrong. You wouldn’t go skydiving without a parachute, or mountain climbing without safety gear. As they say, the higher you go, the harder you fall. Just as a highwire tight rope walker uses a safety net, having a safe stash of money for when a crisis situation strikes is essential. It’s OK to take risks; just don’t put everything on the line. Be prepared for when things don’t go according to plan.
The degree of risk you can take changes with age and accordingly the size of the safety net you need increases. Young people have little accumulated and not much to lose, but they also have the potential to make big gains through taking risk. Those near the end of their working life have a lot to lose and little to gain from risky ventures and so their safety net needs to be bigger.
There are a number of ways you can create a safety net. The most obvious place to start is having a slush fund tucked away somewhere. Working on the principle that out of sight is out of mind, a good place to keep it is in a bank which is not your usual bank. At the very least, make sure it doesn’t appear with your everyday accounts on your internet banking page when you log in. If you have a mortgage, you can keep your interest payments down with an offset arrangement or, if this is not available from your bank, use a line of credit as an emergency fund.
Insurance also forms part of your safety net. In addition to insuring your property and your life, consider whether you should insure your income. Your future income is probably your biggest asset. If you have borrowed heavily to invest in property or a business, income protection insurance should be high on your priority list. Without income or the ability to work you run the risk of having to sell your property or business at short notice. You may not get the price you want or need.
Borrowing brings with it the risk of interest rate increases over time. Build a safety net around your mortgage repayments by leaving yourself some ‘wriggle room’. Instead of borrowing up to the maximum you can afford at current interest rates, borrow what you can afford if interest rates increase by a percent or two. This is particularly important right now with mortgage interest rates at a historical low but heading upwards.
Once you have built up a reasonable amount of wealth, which is probably in mid-life, it is tempting to risk some of it in speculative investments – perhaps property or a business venture. How much money should you put at risk or spend? The rule of thumb at any stage of life is to make sure you have set aside a lump sum or a regular savings plan which will secure for you an acceptable standard of living in your retirement. With that taken care of, additional funds can be invested in risky ventures or spent, without worry or guilt.
Finally, if you are borrowing money or taking any kind of financial risk, make sure your wealth is protected with all the necessary legal structures and documentation relevant to your situation, such as a limited liability company, a trust or a contracting out agreement.
Risk is an inevitable part of life and along with it comes the possibility of increased enjoyment of life. A financial safety net allows you to make the most of possibilities without the fear of a hard landing if things don’t go according to plan.