Money Management

10 Assumptions That Are Exposing You to Financial Risks

September 9, 2022

Financial assumptions are disastrous, and they are hard to catch. You can make them without even noticing you are doing it. And that is because most of these presumptions are typically common. They can be financial tricks passed down to you from parents, or you've seen them work for others around you. They're traditional, maybe even feel safe, so you gravitate towards them.

Making assumptions is easier than taking the high road of researching and making more informed decisions. They allow you to fasten the process or altogether avoid taking action. But when it comes to your finances, any assumption you make can put you at risk of losing money or destroying your future.

This article will explore some of these assumptions, their effects, and what you can do to avoid them. Read on.

Assuming Cash is Still King

Being liquid is okay, but when you keep much of your wealth in a savings account, you expose yourself to inflation and interest rate risks. If the interest you earn is less than the inflation rate, which stood at 8.5% in August, you could unknowingly lose money.

While keeping cash at arms reach might prevent you from missing out on opportunities that demand it and help you deal with other emergencies without going into debt, you should be aware of bigger risks you are exposed to.

Instead of keeping money in the bank, look for other liquid and short-term investments that are low risk. You could not only be saving yourself from loss, but you could also generate extra income or build more equity.

Assuming NHIF is the Only Insurance you Need

Health insurance is important; it can save you from unexpected high medical costs. But it's not the only insurance you need. There are other vital coverages that you have to buy to ensure you safeguard your income and other valuable possessions. Some of the most important ones include

Life Insurance: This cover pays an annuity to your dependents after your demise. This money can ensure they avoid financial hardship and their lifestyle isn't interrupted.

Home Insurance: This policy protects you and your house from unexpected events. This can be damage caused by extreme weather, theft of property, or any liability from your domestic workers and visitors. If you don't own a house, you can get a renters insurance cover which offers some of these perks.

Income Protection insurance: Various events can lead to losing your income, and you should be prepared for it. This cover will help you earn part of your income until you jump back on your feet and have developed a new source of earning.

Assuming Your Life Experience

Most people assume they'll live till they're a certain age, but the hard truth is that death is unpredictable. Therefore, you should strategically plan for the possibility that you might meet your demise earlier than you expect or live longer.

You prepare for early death by having your estate in order. You can do this by always keeping an updated will and appointing a fiduciary to oversee your estate distribution. This ensures that your wealth goes to the rightful heirs, and your legacy can live on through them.

But you should also note that advancements in health care and improved living standards mean people are living longer than ever. Therefore, you should consider factoring in your retirement planning to avoid the risk of outliving your savings and investments.

Assuming You can Fit all Investments Goals in one Portfolio

At this stage, you have various financial goals for saving and investing, like homeownership, retirement, or your kids' education. All these are an important medium to long-term goals that are a vital part of your financial planning and should be planned separately.

Creating separate investment portfolios for different goals allows you to diversify risk. When one investment backfires, all your dreams won't be ruined. Another important reason for doing this is you'll be able to track each investment and keep yourself accountable.

When you pull all your goals in one investment, you might end up prioritising some over others, and this can hurt your financial future, especially in retirement.

Assuming Your Investments Will Bounce Back

When investing in vehicles exposed to market risks like stocks and securities, volatility is expected. Most investors loathe the idea of selling at a loss when their investment is in a downward trend.

This, in turn, forces them to hang on too long, believing that their investments will bounce back. While this is not necessarily bad, especially if you have a high-risk tolerance and you can withstand volatility, you should be able to know when to accept losses and get out of a position.

One trick that can help you when faced with such hurdles is portfolio rebalancing. If you diversify your investments and allocate your assets accordingly, you can revisit them and reverse them to their original form. The gains you realise from other investments will cancel out any losses. Rebalancing also prevents you from exposing your assets to more risks than you are willing to accept.

Assuming You'll Retire on Your Terms

While everyone would like to retire when they're ready and on their terms, that doesn't always happen. And that is because some circumstances might force you to take early retirement or even cause you to work after you've retired. As you make your retirement plans, you must factor both scenarios into your plans.

Different things can cause you to retire early, retrenchment due to your skill becoming outdated or automated, getting terminally ill, or becoming disabled. You should prepare for all possible scenarios by getting the right insurance that protects your income, creating passive income channels, and constantly updating your skills.

Additionally, raising living costs and increasing life expectancy might force you to work after retirement. You will mainly do this to avoid longevity risks and prevent yourself from being dependent on others.

Assuming the Importance of Diversification

Diversifying your investments in different asset classes can help you mitigate risks, which is vital for long-term investment strategy. It can bolster your overall financial well-being and ensure you don't lose much when one investment/asset is exposed to significant risks.

Contrary to popular belief, you don't need to have a lot of capital to be able to diversify your investment. You can invest in different mutual funds that pool money from other investors and invest in various assets.

They're such funds that can cater to you depending on your risk tolerance. For instance, money market funds invest in low-risk vehicles like treasury bonds, while equity funds invest in more risky vehicles like publicly traded stocks and securities.

Additionally, you should explore ways to diversify your source of income. Over-reliance on one income exposes you to financial hardship when that source is interrupted.

Assuming all Debt is Bad Debt

Debt can prevent you from reaching your financial goals, and it can also accelerate the process. It all depends on the type of debt you take on; is it good or bad debt?

Good debt is any debt that has the potential to boost your wealth by helping you create equity over its course. A good example could be a mortgage loan or a student loan. Both these debts have a positive effect on your bottom line. A student loan probably helped you through university and allowed you to have a career, and a mortgage loan ensures your rent money doesn't enrich your landlord but helps you build equity.

Bad debt, on the other hand, is a liability, any loan that doesn't offer financial returns. These are loans you take to purchase depreciating assets, and they generally have high fees and interest rates. You'll mostly find yourself taking on bad debts because you can't stick to your budget or have no emergency funds. An example is uncontrolled credit cards or mobile App loans.

Always ensure that the debt you take on positively impacts your finances. For example, a car loan can be a bad debt, but if you use it to your advantage and pay the monthly installments on time, it can boost your creditworthiness.

Assuming Security is Good

At this stage in life, you might have found stability. You are making enough money to support yourself and your dependents and are on track to achieve your goals. This might tempt you to consider playing it safe and not venture outside your comfort zone. And that's understandable.

But in your 30s, you still have time to explore, and your current financial standing allows you to increase your risk tolerance and capacity. Consider Getting more financially literate or a financial advisor to help you explore options outside your safety zone and take more risks.

Assuming that "Buy Now, Pay Later" is Not a Loan

Buy Now, Pay Later (BNPL) services have grown in popularity in Kenya over the last few years. This type of short-term financing allows you to buy something and pay for it at a future date; the arrangement is often interest-free. The payments are paid in installments over an agreed period.

Even though some BNPL products are interest-free, they still work like a loan. Some merchants will charge you more than the market price, and if you default, you'll be charged exorbitant fees and risk being listed in the CRB, which can affect your future creditworthiness. BNPL can also encourage consumerism and affect your budget if you don't approach it carefully.

Instead of taking this path, you should consider saving and buying a product in cash. This will ensure you don't buy something you can't afford, stay within your budget and avoid bad loans.

WRAPPING UP

Financial assumptions are common; if you are not careful, you might make them unconsciously. The best way to avoid this is to always weigh your decisions before making them. You can only achieve this by doing enough research, getting financial knowledge, and consulting experts.

You should also consider not blindly taking advice from friends and family or making decisions for fear of missing out. What worked for another person won't work for you, and finally, always remember that previous market returns don't guarantee future returns. Always strive to take financial actions that don't put your future at risk, starting with avoiding assumptions.

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Farah Nurow is an experienced Content Writer who enjoys writing creative and educative articles meant to provoke readers' thoughts. He loves sunny weather and thick books. You can connect with him on LinkedIn.