Risk-reward analysis is at the heart of all prudent financial decision-making. It’s just good policy to base your money choices on what you expect to gain, measured against the risks you’re willing to take.
Without risk, there can be no reward, but some people take chances where the potential gains and losses are so out of balance that the gamble simply can’t be justified.
GOBankingRates asked a variety of experts to dish on the reckless wagers that otherwise sensible people are most likely to make — as well as what they would like to see them do instead to put the risk-reward ratio back into a state of equilibrium.
They recounted stories of unnecessary risks in borrowing, buying, spending, planning, investing and the pursuit of business ventures. There are safer, smarter ways to play each and every scenario, so consider the following before putting money down on a chance that isn’t worth taking.
Using Home Equity as an ATM
When home prices are rising fast — like they were in 2008 and like they have been for the last two years — you might be tempted to draw on your equity without any real need to do so. After all, your home’s value can only keep increasing, right?
That’s a question you should ask the people who bought jet skis on home equity loans before the Great Recession, only to end up with underwater mortgages.
“You’re effectively handing over control of your home when you refinance and withdraw cash from it,” said Joe Troyer, CEO of ReviewGrower.
If you’re going to do it, do it only for something that will pay you back in the long run.
“Lowering your interest rate or paying off higher-interest debt are two reasons to consider refinancing,” Troyer said.
Co-Signing for a Loan
When friends or loved ones with shaky credit ask you to co-sign for a loan, your generous side might say to do what you can to help them secure funding while also rebuilding their credit. But if they can’t get a loan on their own, it’s because lenders have decided that they pose too great a risk. In this case, you should trust the bank’s underwriters over your own generous nature — it’s you, after all, who will be on the hook should the primary borrower fail to break old habits.
“Even though you have not acquired the money yourself, you have made it possible for the principal applicant to obtain the loan,” said Veronica Miller, digital marketing and growth director with VPNoverview.com. “If payments are missed, the lender will look for you.”
Chasing Huge Gains With the Next Big Thing
There have always been two ways to gain wealth through investing — the long, slow, steady way that pays over time and the fast, easy way where you get rich quickly.
If the second way worked, everyone would do it.
“People always believe in foolish trends instead of fundamental and technical analysis of that asset,” said Dustin Ray, chief growth officer at Incfile. “I’ve seen people wipe half of their wealth by riding trend waves in stocks and cryptos in the hope of 10 times or 100 times returns. They do not understand the buy and sell points, and potentially the asset class everyone’s talking about has already reached its peak.”
Picking Individual Stocks
ETFs made it easy to create diversified portfolios with exposure to different sectors and categories with the purchase of a single share — yet people still try to beat the market by betting on individual companies.
“The biggest risk that people take is trying to pick a specific stock,” said entrepreneur, author and financial advisor David Delisle, who wrote The Golden Quest to get kids interested in money. “At any given time, our most experienced investors will always disagree on whether you should buy a stock or sell a stock. This is why it’s almost impossible to outperform the market. Nobody has been able to do this consistently. Even our best investors can only outperform the stock market for a short period of time and eventually end up performing worse.”
Quitting Your Day Job To Pursue Your Dream
If you want to make your passion pay, bravo! All businesses start out as dreams. But don’t plan on pursuing it full time until you do the hard work of building your dream into a plan that has a strategy, a budget and a realistic path forward.
“This sounds pessimistic, but turning your hobby into a career rarely pays off unless you have transitioned into it gradually,” said Gates Little, CEO of altLine at the Southern Bank Company. “We love reading stories about people who quit their 9-to-5s to open a dog spa or whatever, but the reality of overnight financial success is that it takes years of grinding away your evenings and weekends. In order to drop your job, you need a robust savings account, as well as an established clientele to keep your business growing. These all take time and effort and sacrifice and won’t just happen if you quit your job to start a business.”
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