Recognizing Risk

In this episode of Rehab Your Finances, Mike discusses the importance of recognizing the role that risk plays in your financial wellness. He highlights common risks such as unexpected expenses, loss of income due to disability or death, risks to property and self, and inflation risk. Throughout the discussion, he emphasizes the importance of considering the data within your specific life situation and goals. Expect to come away with tangible strategies for navigating risk after listening to this episode!

References

• Disability Insurance Statistics and Facts for 2025
• Life Insurance Stats and Trends
• White Coat Investor - Whole Life Insurance
• Most Americans Would Struggle with Emergency Expense
• Bankrate's 2026 Emergency Savings Report
• Threshold of $2467 for Emergency Savings
• Emergency Savings May Hold Key to Financial Well-Being

Music: Perpetual Motion by Amarent via FMA (public domain)

Contact: rehabyourfinances@drmichaelpowers.com

Transcript

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Michael: Welcome to the show. I'm your host, Mike Powers, physical therapist, full-time educator, and certified financial education instructor. In each episode, we'll look at personal finance through the intersecting lens of healthcare and education. Just want to send a reminder that information presented on the show is educational in nature and should not be taken as investment advice. Let's get started. Today, we're talking about recognizing risk. And I think this is an important topic as previously we talked about cognitive optimism. And I cited the evidence that supports optimism being associated with higher savings rate, better health outcomes, in terms of morbidity and mortality. I did not want to just leave it there though, and have people thinking that all you need to do is think positively, because there's some real risks associated with improving your financial well-being and there's risk in life. So optimism is not blind faith that we avoid all risk. but considering risk across various aspects of your life is critical in building a solid financial foundation. We know though that because of risk aversion and not wanting to really consider risk, it's better to start out with optimism, which is why last episode I focused on optimism. And today we're going to dive into risk, but we're going to have the mindset that because we're thoughtful, we're engaged in good planning and preparation, The risk is not scaring us or stressing us out per se. We're just being diligent in how we approach risk. And we're considering that we're really building a solid financial ship that can weather a variety of storms. On a personal note, my introduction to risk as it relates to personal finance happened when I was reviewing materials at work for 401k plans and investment opportunities. And I distinctly remember the questionnaire that I was looking at asking, what's your risk tolerance? And being a novice at that time, not knowing much about investments, I thought, I don't know, medium. I didn't know what the right answer there is. And it struck me as I've thought about this, that risk is always highlighted when asked about investment decisions. What should my portfolio be? Where should I put my money? But I haven't really encountered many holistic discussions about risk as it relates to personal finance. And that's what we're going to focus on this episode. Let's talk about risk a little more holistically today and how different risk considerations can impact your financial well-being. Thinking back to content we presented last episode, risk is going to scare us because remember loss aversion. We're much more concerned about or it's much more painful to have a loss than it is to have a gain. So we are as humans wired to want to avoid negative outcomes. This is a big emotional consideration because emotionally we're drawn to commit errors in how we think about risk management. When we're emotionally drawn to avoid risk, we're not really thinking straight and again, it's not our fault. This is the emotional aspect and I'm not negating the importance of emotion. I'd like us to be a little more rational in how we think about risk. So we avoid some decision-making mistakes. If we're getting emotional about risk management, we may either avoid risk and think, well, bad things happen to someone else. I'm not going to think about it. This avoidance and denial puts us in a bad spot. Or we might commit errors in decision-making when attempting to mitigate risk by over-protecting against risks that are unlikely to happen, and that can have a negative outcome as well. To that consideration, many financial products in the financial space are designed to capitalize on the fear associated with risk management. They're designed to sell you products and services that aren't in your best interest. These products are designed to make someone else money. Here we think about whole life insurance and extended warranties. Those are services that from a numbers perspective don't make a lot of sense. And I'll talk a little bit more about whole life insurance later in this episode. But these are products and services designed to get you to think, well, the person selling it to me is telling me how important it is. I am fearful of loss, so I better sign up for this. Another thing that'll happen here is poor decision-making. has a compounding effect. And this can happen in my opinion, in multiple directions. One area that may not be obvious in the beginning is we can make some poor decisions and get good outcomes. And then that is going to have a compounding effect because when our poor decision making gives us good outcomes, we erroneously think, well, I made the right choice. I'm going to continue to make this choice. And we may have got lucky on that one spin of the roulette wheel. And we keep betting all our money on one number or one color. And we just continue to make bad mistakes that hurt us down the road. And these bad decisions compound over time. Another way bad decisions can compound over time is if we think about avoiding risk completely, and maybe we decide, well, we're not going to invest our money. We're going to put our money away somewhere safe. So not investing early to avoid risk has a compounding effect because we've not benefited. from actual compounding in the market. So we can make mistakes in many directions. And as we talk about risk today, I want to make sure that we're clear headed, really getting a sense of what's realistic in terms of risk. So we avoid some of these decision-making errors. In my opinion, managing risk is improved when we're clear about our values and priorities. So we can intentionally protect ourselves while moving forward toward our goals. The framework then that I'm going to propose is, I keep coming back to values and priorities, and you may be thinking, well, isn't this a financial podcast where the numbers, the numbers are going to make sense only in so far as they are a means to be consistent with your values and priorities. So I can't tell you which risks are more or less important to you. We're going to highlight some risks, but that decision-making clarity really comes from understanding what's important to you. and your family and your career, and then you can make solid decisions about risk. Couple categories of risk that I'll be discussing today. And the first one I want to hone in on is the risk of unexpected expenses. The so-called dreaded unexpected emergencies that hit us at the worst possible times. And the data here is not great in terms of most US households. And I'll put the references to some of these numbers in the show notes. Fewer than half of Americans have enough funds, so have liquid cash or have money in emergency savings, to cover a $1,000 emergency expense. So something unexpected happens, fewer than half of Americans can withstand a $1,000 unexpected expense. What this means is people in this category might be, by necessity, having to make the decision to go into credit card debt, payday loans, et cetera. getting behind the eight ball a little bit and it's hard to come back from. A 2019 paper by economists, Sabbath and Gallagher looked at a lot of data. So this is seven years old. This number that they're gonna recommend has probably gone up a little bit to account for inflation. But based on their research, they recommended the threshold point of $2,467 as being sufficient to successfully withstand unexpected expenses. I like this paper because it's saying when we looked across a variety of areas and these are some smart economists that put the numbers together, that's really what you're looking at. Now granted that's higher than the $1,000 emergency fund we mentioned, more than half of households can't cover, but I like that because it gives you a clear cut number of here's what the data actually shows. This is backed up by a 2025 Vanguard survey. where this survey found that $2,000 in emergency savings reduces the likelihood of financial distress and enhances overall mental well-being. So the risk of emergency expenses needs to be on your radar. It's life. It's going to happen. The data suggests that anywhere from $1,000 to $2,467 should be an initial target, and that gives you a good goal to progress towards. in terms of being able to withstand unexpected expenses. I previously mentioned that knowing your priorities and values is important when you're looking at mitigating risk. I do think though, as it relates to unexpected expenses, these are going to happen to all of us. So a high priority in terms of managing risk is really going to be looking at that emergency fund and aiming for something in the area of one to $2,000 to start out with. That's gonna be a good sleep well at night number and get you to a better financial position and a better mental health position in terms of these unexpected expenses. Other risk categories that I wanna talk about would be risk of loss to your income. And the primary ways that I could consider risk of loss here would be through disability or death. Probably not the happiest topics, which is again why I wanted to lead with optimism last episode before we got into some of the deeper categories here. But let's talk about what the numbers say in terms of disability. And again, anything I reference is gonna be in the show notes so you can see where the data was pulled from. It's estimated that one in four of today's 20 year olds will experience a long-term disability before age 67. So that's one out of four. The odds are against a disability, but that might be a little bit higher than what you would have initially thought. The unemployment rate is twice as high for individuals with disabilities. So disability does have a significant impact on your ability to earn an income. Over a lifespan, we find that rates of disability rise with age. Why this presents a specific risk is multifactorial. One is obviously if you're disabled and can't work or you're disabled and have a harder time finding work. there's a loss of income. The other consideration is if you're thinking, I'll just go on Social Security Disability. Unfortunately, there's some bad news there. The average denial rate for Social Security Disability is 68%. To get on Social Security Disability, you need to document total disability. And the average benefit for Social Security Disability is $1,582 per month. If you have a keen handle on your finances and your numbers, you may know whether or not that 1,582 per month is sufficient in your situation. For most people, that's probably not going to be sufficient. I'm not advocating at this point that everyone needs to rush out and get disability insurance. I presented the data here so you can consider what in your situation is your perceived risk of disability, which you have the opportunity to pivot into a different Early in my career as a physical therapist, I worked with so many individuals with spinal cord injury. I was convinced that I would have a spinal cord injury myself and I had a backup plan. Who knows if it would have worked or not, but I had a backup plan that I would go back to school and become maybe a mental health counselor, which could be done at various levels of disability in terms of mobility or needing to use a wheelchair for mobility. That was my calculation at the time. Other thing to consider in addition to can you pivot into a different career would be, do you have an ability to self insure? And here's where we talk about that emergency savings again. If you have multiple months of emergency savings, if you were to sustain a disability, can you ride out? Maybe it's a short term or an intermediate term disability. You don't need insurance because you have enough saved up that you could weather the storm. And again, we're using that analogy of we're building a good boat. so you can weather the storms that life throws at you. Life insurance then is a consideration for what happens to those in your care should you pass or should you die earlier than expected and your income is lost. Obviously there's the catastrophe of an unexpected death, but the reality of it is if you're the primary income producer in the family, we wanna make sure that our families are well taken care of. And maybe you're a dual caregiver, maybe you've got elderly parents you're caring for, maybe you have a spouse, maybe you have children or other dependents, considering life insurance is very important. Good news is based on the actuary tables and based upon data that's out there, life insurance policies typically aren't needed, but it's a protection against the very rare yet catastrophic event that could happen. Now, because of this, because these payouts are not that common, And here I'm going to talk about term life insurance. So let me underline that. We're talking term life insurance, which is a amount of coverage over a set number of years. And then the policy goes away. My recommendation would be to think about term life insurance that's covering you for the term of which your income is needed. Personally, I have a term life insurance policy that's set up. I believe until I'm age 65, I need to go back and actually check my policy, but it's set up to offset the loss of my income should I pass earlier with the thought that maybe if I'm retired at 65, I'm not bringing in that income in my retirement accounts then become what my family would rely upon. Earn life insurance because it's not often paid out is relatively inexpensive. In looking at some of the numbers for a $500,000 policy, It would be $250 per year on average for a 30-year-old, $365 per year on average for a 40-year-old, and $882 on average per year for a 50-year-old. That's not a lot of money. For a 30-year-old, you're looking at $20 a month. And should you pass early, you're getting a $500,000 policy. I'm not going to go into details in this episode about calculations, how much life insurance do you need. I'm merely pointing out that this is a low frequency but high catastrophe event passing early. Because of that, the cost is relatively inexpensive. I do think term life insurance is something you absolutely want to consider, especially if you have people that rely on your income. Make sure if you're looking at life insurance, you are considering term life insurance and not whole life insurance. Whole life insurance is an expensive product that is generally making money for those that are selling the policies and it's a bad product because it's trying to be both an insurance and an investment vehicle. And anytime something with your money is trying to guarantee you no risk and high returns or is trying to give you the best of both worlds, it's probably doing a poor job at both and it's probably making money for someone else. So I would wholeheartedly recommend for 99 % of people, don't look at whole life insurance. Recommendations then for life insurance, absolutely look at term life and avoid whole life insurance. Other risks we need to consider are risks to property and self. And I've bundled, guess bundling is the common thing now anyway, but I'm bundling the considerations of health insurance, auto insurance, and homeowner and or rental insurance together. The reason I've done this is I think we can conceptualize these types of insurances somewhat similar in terms of thinking about, do we want policies that have a large deductible? So in some ways, am I self-insuring by having, again, here we go with that big emergency fund, am I going to have lower monthly payments because I have a larger deductible? Does that make sense for where I'm at? Or would I not be able to cover a large deductible, I need to pay more per month or I need to hire monthly payments with smaller deductibles because I just couldn't handle something big happening. So one would give you a little bit better monthly cash flow, but you would have to dip into emergency savings. The other is going to cost you more per month. But if something happened and you had a claim, you wouldn't be responsible for as much. This is going to be very specific to your individual situation. Again, I think we can conceptually think about health auto and homeowner or rental the same way. Think about how much would you want to pay out of pocket? How much would that lower your premium? Kind of a sliding scale there. One thing that I have not done yet, but I'm going to be doing on the next go round as I look at ⁓ shopping around for homeowner and car insurance, which is recommended due annually or every other year. There's really no benefit to. having loyalty to companies, you can usually save some money by shopping around a little bit. I'm going to be looking at using AI to check some of these policies. I don't know about you, but for me, as I read these policies, I don't always have a clear understanding of what's covered and what's not covered. They're not always written the cleanest. So I've worked with some people who have started using AI to check the policies and they've been very happy with that. So that's something I'm going to be doing myself and that's something you may wanna look into as well. before you sign up for any changes and policies. Get a copy of these policies, maybe run it through AI, check to see what's actually covered and check to see if you're switching policies, whether those changes make sense for you. The final risk I wanna talk about here is inflation risk. And I think this is one that was under a lot of people's radars probably prior to, was it 21 or 2022, when we saw inflation ticking upwards of eight and 9%. and really chewing away at people's purchasing power. The Federal Reserve Board, their goal is to keep inflation at around 2%. So in your head, you want to think about, if all things are going great, generally things are going to get more expensive by 2 % a year, but we've recently seen that go much higher. So we need to think about risk of inflation as something that eats away our future purchasing power. The way we want to think here is where are we putting our money that we're quote unquote saving for later. With inflation, unless you're getting a great return in a savings account, you're really, and even if you are, you're not going to be able to save your way to a good retirement. Currently high yield savings are paying out three-ish to four-ish percent. If inflation's right about that rate, you're not really staying much ahead of inflation and you're losing you're going to end up losing purchasing power over time. Generally speaking, as you put your money away for retirement, your expected returns are going to be correlated somewhat with risk. That's where you think about, well, do I want to invest in stocks, in bonds, in real estate? Where do I want to put my money? And here risk becomes a different sort of consideration that when we invest, we accept some measure of risk because that helps drive some of the return. But big picture here as it relates to inflation, I want you to think about if I can't handle some amount of risk when I save or invest my money for later, I'm now exposed to risk from the other side, which is I'm now losing purchasing power. It may seem that I'm doing the safe thing by putting my money in a savings account or stuffing it proverbially in the mattress, but that's actually a very risky activity because now I don't have enough money for when I need it. later on. Here's where a careful consideration of your short-term, intermediate, and long-term goals really comes in. A lot of people I talk to will wonder about, where should I put extra money? And there's no right answer that fits everyone because it depends on how quickly do you need that money? What do you need this money that you're saving to do? And that will determine where you want to eventually invest or save that money. To summarize and to look ahead to next episode, today I've made the argument for the thoughtful consideration of risk across multiple areas with reflection on how risk may impact your life and goals. The importance of an emergency fund has been mentioned multiple times today, and that's for a very good reason. The emergency fund is your first line of defense against many of the risks that we've discussed. building out this emergency fund protects not only against unexpected expenses, it's gonna allow you to self-insure in many situations and it really builds out your financial wellness. It allows you to absorb more hits that life's gonna throw at you. Depending on your circumstances, I would recommend considering the benchmarks of either $1,000, $2,000 and or $2,467 to be a goal because those are evidence-based benchmarks. And these should be your priority goals for establishing that emergency fund because that is your first line of defense against risk. Looking ahead to next episode, I'll be talking about getting a handle on your baseline financial numbers because as we know, what gets measured gets managed. For these baseline financial numbers to have an appreciable impact, reflect upon your thoughts regarding money, specifically what we've covered in the last two episodes, optimism and risk. Think about what's important to you and your family and where you would like to be in the future. Think about one year, five year and retirement timelines and realistically what risks you may need to consider as you go through these goals at these various timeframes. If you reflect upon your money scripts and tangibly and vividly establish your priorities, the numbers we dive into next episode will be much more meaningful. Thanks for trusting me with your time and attention. I look forward to connecting with you in the next episode. Until then, I encourage you to consider how your priorities and values are reflected by where you direct your spending. We'll be diving into this topic next episode.