Did you know there are ways you can reduce the odds of financial risk in your life? While you may think of risk as something related to the stock market and your investments, there is a bit more to it than that. 

For the noun RISK, the Merriam-Webster dictionary defines it primarily as follows: 

1. Possibility of loss or injury
2. Someone or something that creates or suggests a hazard

Years ago, our founder and CEO Rick Adkins developed the Risk Capacity Index^SM (RCI). This Index was simply a tool to help us communicate to our clients the importance of good planning and areas of risk that could be addressed. For you, the same concept may be used to highlight areas of exposure to financial loss and unplanned expenses. While we do not routinely use the RCI as a communication tool these days, it is still part of our evaluation of how your portfolio should be positioned, as well as other areas that need to be addressed as part of your overall financial plan.

The six areas are as follows:

1. Life expectancy—How healthy are you? Two elements are impacted here: the number of working years you have (if you are young) or the number of years in which your portfolio needs to support you (if you are retired.) A young person with more working years ahead has more risk capacity than someone who is close to retirement or already living on his/her portfolio.
2. Income—Are you living within your means? Although a high income certainly helps, it is more important to measure the extent to which you are living within your means. If your fixed expenses are low relative to your income, you can withstand financial disruption much easier than someone who is living paycheck to paycheck. Perhaps more importantly is protecting this income—if possible—through disability insurance. It is one way to mitigate the risk of losing your income due to an accident or medical issue.
3. Investments—How much of your future financial need have you already saved? To the extent you already have substantial savings, and continue to fund for future needs, you have created a bit of space to either be a bit more aggressive (if desired) or simply be better prepared for market volatility. You will also have less pressure in the future to make-up for a late start in retirement savings.  Looking at the level of risk in your investments is also important. Trying to make up for a late start in saving by being more aggressive than your tolerance or capacity for risk is a common mistake. Those who attempt to do so may feel they have created additional financial pressure, and ultimately this plan may backfire.
4. Liquidity—How much emergency cash savings do you have? Cash savings, such as 3-6 months of emergency reserves, is a good financial move. Now that some banks are paying a decent rate, there is no reason not to keep some extra cash on hand.  
5. Debt Level—How much debt do you have? What does it relate to? Oddly enough, we are not against debt. However, not all debt obligations are equal. Credit card debt that cannot be paid-off (or even paid down) each month is a higher risk situation than having a reasonable mortgage or car payment. These types of obligations are to purchase assets, which you could sell to eliminate the debt if necessary. I would put owing a loan shark as the worst type of debt, followed by owing back taxes to the Internal Revenue Service, or paying off a Disney vacation that you took 3 years ago. 
6. Responsibilities—How many people are you responsible for? This area looks at the number of dependents and extent to which preparations are in place to care for family members in the event you pass away or become disabled. To the extent there are sufficient assets or life insurance and legal documents in place (such as a will or trust instrument and other directives), this increases your capacity for risk.

The good news is of the six areas, the easiest to start with and adjust is cash savings. For years, we have preached the importance of the Savings-to-Spend account as not only a clever tool for managing cash flow, but also as a source for emergency savings. To the extent that cash savings are addressed, it is amazing how the other areas can be addressed in a way that improves your capacity to weather financial storms and, if desired, take on more financial risk. Understanding risk capacity ultimately will help you make better financial decisions.

“Risk.” Merriam-Webster.com Dictionary, Merriam-Webster, https://www.merriam-webster.com/dictionary/risk. Accessed 15 May. 2023.

Kristina Bolhouse, CPA/PFS, CFP®

Vice President/Shareholder

© 2023 Kristina Bolhouse and The Arkansas Financial Group, Inc., All rights reserved.

The Arkansas Financial Group, Inc. is a Fee-Only Financial Planning Firm located in Little Rock, AR serving clients in Arkansas and throughout the country.

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