Where Do You Stand on The Risk-O-Meter?
A recent Wall Street Journal article called The Truth About Wealth contained an interesting quiz. The more points you get on the quiz, the higher your wealth beta. In stock terms, a high beta means a high possibility of risk (and the flip side, reward.) In Las Vegas terms, a high beta would be like the roulette table. Plop down all your money on 40 on one spin of roulette, and you stand to make a bundle if your number comes up — but you’re almost certain to lose it all.
At any rate, two of the questions from the quiz seemed especially eye-opening to me:
- Is your total annual spending relative to net worth…less than 3%, between 3%-5%, or more than 5%?
- In social or business situations, do you believe you are the smartest person in the room…never, sometimes, or most of the time/always?
First off, do you even know how much you spend annually? I didn’t, but since I live in spreadsheet land, I went through the past year’s worth of net worth information and figured it out. And….ouch. Do I really spend that much? I must, because the total blinked at my from my computer screen. It was bad enough looking at it on a monthly basis, but annually was even scarier. Luckily, a lot of my spending is actually going toward debt reduction. (We’re on the last item, the mortgage.)
Second, I never really thought about it before, but it stands to reason that it does matter what percentage your spending makes up of your net worth. That’s absolutely critical to keep a sharp eye on if you’re retired, but it matters to the rest of us too. Why? Because naturally the more you spend, the less we have available to build wealth. If you want to become — and stay — wealthy, you’ve got to watch both your income and your outgo.
And the other question?
On believing you are the smartest person in the room…
I loved the “do you believe you are the smartest person in the room” question because it points out that our beliefs matter.
I’ve always been strongly convinced of that, but the question pointed it out in a different way. You see, if you pretty much always believe that you’re the smartest person in the room, you’re likely to take on more risk without fully examining what could go wrong.
It’s easy to think that you know best, but the reality is that it doesn’t matter how smart (or dumb) you are financially, so long as you’re smart enough to make sure that you live the basic tenets of personal finance each day:
1. Spend less than you earn.
2. Always save and invest for the long term.
3. Do what matters to you.
If you think you’re smarter than the rest (and who doesn’t, sometimes?) you’re more likely to believe that you’re getting in on great deals that others just aren’t able to see. The reality is, you’re more susceptible to risk — both to taking on too much of it, and to being blindsided and unprepared when things go wrong.
So where are you when it comes to risk? How do you handle it?
(Thanks to Family Money Values’ post on high beta wealth and the Forbes 400 for pointing out that quiz.)