Financial Literacy - How to Prosper
investing
Taking financial risks without regrets

Living life without risks would be impossible, not to mention boring. The risk spectrum is wide, ranging from simply riding in a car to treacherous rock climbing or sky diving. Some forms of it, such as financial risk, threaten your pocketbook rather than life and limb.

Decisions like buying a home, starting a business and stock-market investing can result in big pay-offs -- but they can have downsides as well. Luckily, with a little risk management, individuals can mitigate potential problems.

Buying a home

Due to recent events, a home purchase is viewed more suspiciously than in years past.

"I don't think that people considered mortgages a risk in the past. It's only in the past three years that we are looking at them as a risk," says Jeri Lynn Fox, president of the Illinois Association of Mortgage Professionals.

But taking out a mortgage and buying a home does entail risk-taking. For one thing, it's an expensive loan spread over many years, typically 30. A lot can happen in three decades, even if you don't get caught up in lousy mortgage terms or owing more on a mortgage than your home is worth.

Consider the attendant costs of homeownership: property taxes, homeowners insurance and, for some, homeowners association dues, as well as the cost of maintenance and repairs.

"When something breaks, you don't get to call the management anymore. You get to call the plumber when the toilet backs up, or you get to call the appliance repairman when the refrigerator conks out," says Jim Smith, a CPA in Dallas.

Homeowners can lessen that risk by purchasing a warranty insurance policy.

"It's like an extended service policy on your car that will pay for repairs. There is an insurance premium on that that you have to pay," says Smith.

Another general risk involves buying too much house. It's easy to mitigate that danger simply by scaling back your expectations.

"Whether we like it or not, a mortgage is an investment that, whether you have the money coming in, you have agreed to pay monthly. You may not be comfortable paying as much as the qualification ratios say you can pay," says Fox.

For instance, lenders generally advise that your mortgage payment should not exceed 28 percent of your monthly gross income.

"Many families with two incomes like to qualify with just one person's income because one person may be laid off," she says.

Starting a business

Starting a business is a huge risk even as it is considered the best way to get seriously rich. But it is fraught with peril and uncertainty, and there's no guarantee of financial security.

To insulate themselves from the downside, entrepreneurs should have a large reserve of cash to see them through the lean ramp-up period.

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Darlene Butts, author of "Lessons From the Depression: Eliminating Debt the Old-fashioned Way," struck out on her own as a financial adviser right before the stock market plummeted in 2008.

"We had taken the risk and thought that we had covered our bases. Nobody could have foreseen what happened in 2008 and the beginning of 2009," she says.

Because she had planned for the worst-case scenario, she had enough money to cover her expenses for a year.

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