Risk—to some the word is invigorating, and to others terrifying. But do you understand all the risks that accompany a business? Understanding risk boils down to what type of risk you’re facing. In this industry, I’ve identified four kinds of risk. So we’re going to peel back the layers and see what risk is really about.
On the surface you may think that business and politics are inherently separate, but political risk should always be considered in your decision making. To do otherwise is careless. Whether you’re making business decisions, investment decisions, or personal decisions, the choices you make don’t happen in a vacuum. The political climate can absolutely impact you and what you’re trying to accomplish, so stay up to date. Understand the implications of your decisions within the political sphere, and vice versa.
Take Brexit, for example, and the impact it has had on a lot of businesses and investments. If you didn’t account for political risks, you could really get clobbered by Brexit depending on where your business is based and how it is set up.
What is happening in the economy? We truly are interconnected, and the world economies are also interconnected. What happens in one economy will have ripple effects on the other world economies. The politics of one country can also impact the economy of another. Staying ahead of the tide and being aware of what’s happening in the world is in your best interest.
We’re living in a world that’s fractured right now, polarized. You’ll see it almost anywhere you look these days, and you must look. It will have an impact on your life, your businesses, your stocks, and more. And as it’s closely linked with economic performance, staying knowledgeable can help you answer economic questions. Are we due for another recession, or are we due for a depression? Are we due for an economic boom? The economy has a cycle, even if it’s difficult to make exact predictions within the cycle. We’re not in the crystal ball business, so we’re not going to guess at what will happen. Instead we choose to look to history for examples and attempt to measure from there.
As Mark Twain would say, “History doesn’t necessarily repeat itself, but it sure does rhyme.”
This isn’t just about the stock market, this is about being aware of the risks your specific market is associated with. Are you in real estate, bitcoin, technology, commodities, or something else entirely? If you’re investing in a market, you should be doing your research. Each market comes with unique risks, and understanding them helps you navigate or plan for them.
Most people are aware of political risk because of the world we live in right now. Brexit, for example, is an international topic, and even in the UK they’re debating the issue back and forth. It’s like a tug-of-war. So I would safely say that most people, these days, are aware of political risks. Additionally, most people are aware of economic risks—they’ve been through a recession, and many people have relatives who have lived through the Great Depression. Market risk is also in the public awareness because of the housing and real estate collapse in the US, and because of stock market crashes. And then there’s institutional risk, which is less prominent in the minds of people today, but very important.
Institutional risk isn’t about what currency you have, or what country you’re in, it’s about who is holding onto your money. What bank, what brokerage house, what real estate operator are you working with? What companies do you invest in?
These questions are important to ask when you’re looking to use or store your cash, because these institutions exist within and operate around politics, economies, and markets. Do your research, and determine how safe your money will be, what policies are in place, and what you support. Some companies have better track records than others. Some have proven success rates in the face of economic crises. Make informed decisions.
Systemic vs. Non-Systemic Risk
When you look at the list, you’ll notice that the first three items are systemic risk, while the fourth is what I would call non-systemic. What I mean by this distinction is that that sector is so baked into the systems in place, no matter the country, that a small disruption would affect the whole sector or market. The political landscape of a country will have ripple effects all the way down; it’s a system that dictates society. Changes in the economy will have a ripple effect as well, and if the economy were to crash in one area, the whole economy would crash. Markets, too, are systems within their respective niches. When the stock market crashed, it wasn’t just one stock, or one sector, the whole market crumbled.
A non-systemic example, however, would have to mean that if a particular institution went down, it would be an isolated incident. Everything in the same sphere could still be able to continue as usual. If a specific bank, company, or otherwise were to crash, the other surrounding institutions would still be okay.
Non-systemic risks don’t necessarily make you safer, but they require that you do your due diligence when entering into business. Know the history of the companies you work with, and know who is running them now. You’ll come out of a risk in better shape if you go into it better prepared.
The Fifth Risk
Although it’s easy to make a list of things that are risky when it’s outside of ourselves, we must also recognize that we are risks to ourselves. The decisions we make always carry some level of risk, but we position ourselves better when we are informed. Be knowledgeable about your strengths and weaknesses as an investor, do your homework, and understand that the definition of risk. We often associate risk with reward, but it is also the likelihood of failure. Approach risks with the appropriate understanding, and you’ll position yourself for better success.
You can listen to my new podcast, Cashflow Investing Secrets here.
Live your Freedom, Live Your Legacy, On Your Own Terms,
M.C. Laubscher is a husband, dad, podcaster & Cashflow Specialist. He helps business owners and investors create, recover, warehouse & multiply cashflow. You can learn more about exclusive cash flow strategies in M.C.’s new video series at https://www.yourownbankingsystem.com/
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