Stress Testing

Being intentional with your financial position depends on planning and creating habits that foster improvement.  One element often overlooked is stress testing a wealth management plan.

Too often families just go buy insurance and think that their financial plan is protected.  But insurance is just a financing tool and doesn’t have anything to do with minimizing or controlling risk, or recovering from a loss outside of just having money, or of addressing risk exposures that don’t fit inside the contract of insurance.

A better process is to save the act of buying insurance for the very last step  –  after you’ve identified and analyzed the things that could interrupt or derail your financial plan, after you’ve created steps to try and avoid or mitigate the risks that remain, and after all other financing options are investigated. The habit of just asking “what would happen if…” immediately improves your chances of being prepared to deal with it.

Photo: Rachael McGraw, Paris, France

Attitudinal risks in the planning process

Perhaps a bigger risk than an interruption of income, or a physical destruction of an asset, or a lawsuit, is the risk that our heads aren’t squared on straight as we go through a planning process about our wealth.  I’ve been reflecting on my role in that process and it dawns on me that we each bring our own biggest risk to the planning table – it’s us!

As I think of the cases where I worry about a family’s risk to future events, it’s rarely because I predict frequent accidents, or thefts, or injuries.  Instead, I realize now that what gnaws at me is the feeling that their attitudes toward risk and making an investment in risk management is itself their biggest exposure.

With perhaps greater thought I will categorize these better, but here are some attitudes I frequently see that I think are detrimental to sound wealth risk management planning:

Apathy – It won’t happen to me

Ignorance – My contracts protect me from lawsuits / I’m already covered for that

Disclosure – If I can keep it a secret I won’t have to deal with it

Gaming – I’ll just tell ½ of the story  so I can get what I want at a lower price

Inconsistent Expectations – I want high deductibles but all my claims paid / I want the best coverage and service but also the lowest price

Under-involvement – I’ll just do what you guys say I should do

Believing the Hype – The salesman told me ____

Skepticism – You don’t need to know that in order to get me what I need

3rd-party Influence – My buddy told me ___ / I saw on TV ___

Photo: Rachael McGraw, Faxafoss, Iceland


The second-most overlooked risk


Nothing statistical here, just anecdotal evidence from 25 years experience that makes me believe that the second biggest risk to wealth is the general inclination to not believe that risk exists.

I’ve said many times that my biggest competitor is apathy.  If you’ve never been sued, or have never been sent to collections for medical bills, or have never had a business failure, or have never lost money on the sale of a house, or have never had a dispute with a business partner, or have never had to rebuild a significant part of your balance sheet, it is perhaps understandable that talking about risk may seem unnecessary.

But I think it’s no accident that attorneys, business-transition consultants, CFOs, and self-made millionaires (started a business from scratch) are some of my best clients.  Experience is a fantastic teacher and we all learn about our priorities and motivations when we go through something we never want to go through again.

Photo: Dome Church, Paris, France

The most overlooked risk

Statistically speaking, nearly every bit of wealth creation comes from the ability to work.  Whether it’s in the employ of someone, the invention or creation of something valuable, or an entrepreneurial enterprise, the proceeds we earn in excess of our inputs is our wealth.  Whether you save and invest or buy real estate or put money back into your business, the impetus for building your financial capacity comes from earning an income.

So why is it in our financial planning we worry so much about stock market volatility, taxes, lawsuits, car accidents, and fires and spend very little time creating structural protections against an interruption to our income-earning potential?

The risks go beyond disability, death, and what insurance salesmen will want to talk to you about.  Just one example?  Check out this article from The Economist .  It’s not pessimistic to think and plan and analyze, it’s just smart.

Emergency Reserve Funding

Why do you need an emergency reserve fund?  Every financial plan has a reserve-fund component, but few planning discussions go so far as to detail what scenarios might cause you to actually need one.

If you wrote down a list of what those scenarios could be, you’d probably group them into three categories – those that involve the loss of income, those that involve the loss of an asset, and those that involve the introduction of a new expense.

In order to pay for those scenarios you’ll need to use some combination of income, savings, and insurance.  Deciding on the right mix of those can be difficult, which is why we strongly advocate going through the exercise of planning for the possibilities with your financial advisor.

4 methods of boosting your financial resilience

Addressing the chance that at some point in the future you’ll be confronted with some hit to your financial capacity sounds like a pretty negative exercise.  Talking about the things that can go wrong in your life will make you sound like Chicken Little, but sound financial planning demands we act like grown ups and deal with it.

We’ll talk some other time about the process of identifying risks to your wealth, but let’s first put titles on the 4 ways you can improve your resilience to those risks.

  1. Avoidance.  This method involves you not doing something that would expose you to risk.  Don’t want the neighbor kids suing you for them breaking their legs on your property?  Don’t buy the trampoline.  Don’t want to be subjected to the chance you get sued for wrongful eviction by a tenant?  Don’t become a landlord.  Pretty simple.
  2. Mitigation.  This approach tries to reduce either the severity of a risk (how bad it can be), and/or the frequency of a risk (how likely it is to happen).  Instead of buying a 1000cc motorcycle as your first bike, maybe start with a scooter.  Fire extinguishers, suppression sprinklers, and exterior brush removal are good examples, too.
  3. Financing.  This is insurance.  Paying someone else a manageable sum in exchange for a promise that they’ll pay an unmanageable sum for a pre-agreed set of risks is the concept of insurance.
  4. Transfer.  This is where someone else takes responsibility for the consequence of your loss.  This is not insurance.  A hold harmless agreement, an indemnity agreement, an additional insured position are common examples.

Don’t talk about insurance, but let’s chat about financial resilience

Even I mention “insurance” a lot.  It’s partly bad habit and partly because common vernacular and understanding demands it.  It’s what folks expect.

But insurance is just a product, a financial tool to accomplish something more important.  Nobody’s in the market for an insurance policy.  But they are in the market for financial resiliency.  The ability to weather a sudden and impactful storm of serious consequence, whether because of a fire, or a serious injury, or being sued for something you did (or didn’t do), or having some part of your financial life stolen from you, is what every family wants.  It’s what they’re shopping for when they buy insurance.

I think consumers would be better served if we stopped talking about insurance, took the labels off, and started talking about building a strategy to improve financial resiliency.