The risk/reward spectrum – how it all works

The products you chose depend partly on your risk profile. This in turn depends somewhat on factors like your personality, financial situation and age – it may vary according to the stage you have reached in life. As we age, we usually become more risk averse.

It can also differ according to the nature of a life event – for example, someone who needs money quickly in an emergency is less likely to consider the risks of borrowing the funds.

The amount of risk faced by someone in terms of a given situation is calculated by looking at the joint effect of the probability of the risk happening and the impact and severity of that risk if it does occur. So, before a person chooses a product to fulfil a want or an aspiration, they need to consider what risks they are taking and how great these risks are. They can then choose a product that carries the amount of risk appropriate to their risk attitude and situation.

It is important to remember that all financial products carry some risk and there is no risk-free savings, loan or insurance product. One of the reasons why some people get into financial difficulties is that they are unaware of the impact a particular loss might have on their finances and are therefore unable to manage that loss if it happens.

The greater the risk someone takes, the greater the reward they want to receive. Looked at the other way around, someone who wants to receive a high rate of return for a savings or investment product must be prepared to take a greater risk to achieve it. How much a person is prepared to risk in their financial plan is closely linked to how much they are prepared to lose.

Someone who chooses a riskier investment has a different view of the balance between risk and reward. They do not want to lose their money, but they are prepared to take a higher risk to have the chance of a higher return.

There is basically a spectrum of willingness to take higher levels of risk, with people who want safety and accept a low return at the one end, and people who want to earn a high return and accept a high risk at the other end. Where an individual person stands on that spectrum depends on several factors:

The Effect of External Factors

Your financial decisions can be influenced by a number of external factors that are mostly beyond your control. For example, a period of low economic growth will result in people losing their jobs and being unable to pay their bills. Those who are still in work may decide to borrow less. External factors affect people’s wants and aspirations, their plans and their ability to succeed in those plans.

Financial products to protect you

Unforeseen events can have negative impacts on you and your family. There are steps you can take to mitigate the impact through different financial products. There are a range of insurance products available to provide protection for you or your loved ones. Insurance coverage can include:

Living beyond your means – avoid this pattern

If you don’t manage your money properly, it can easily lead to you ‘living beyond your means’ i.e. your income does not cover your spending. Signs that you might be in or heading for financial problems include:

• You don’t have savings for an emergency fund.
• You use credit to pay for everyday items.
• You only pay the minimum amount on your credit card.
• You miss bill payments and are in arrears with payments.
• You borrow money from family, friends or other sources.
• You have a high amount of borrowing in relation to your income. This is known as a high debt to income ratio and means a large portion of your income is required to go towards paying off your debt each month.

Once you put your budget in place and monitor this over some months, you will get a picture of your earning and spending pattern. This will help you see if you are in unmanageable debt.

Why it is important to repay debt – don’t get stuck

You’ll usually pay more interest on your debt than you can earn on savings. So, using extra money to reduce the cost of borrowing means you are better off overall. The most expensive borrowing products are usually credit cards or store cards, followed by overdrafts and loans.

Debt can negatively affect your credit rating score and stop you obtaining types of credit such as a credit card or loan, it can prevent you from buying things you aspire to have like a house. Debt can also significantly impact your mental health through money worries and have a negative impact on your relationships. Failure to pay can have negative consequences.

Dealing with debt

If you fall into debt, you can take action to help the situation:

Trying to increase your income

• Selling an asset such as a car or jewellery and using the proceeds to repay debts.
• Claiming all the benefits you are entitled to.
• Taking on more work or seeking other income streams.

Getting help and advice

• Contacting your bank for help.
• Getting free, impartial advice from debt organisations.
• Creating a debt management plan to calculate what you can afford to repay and changing products or negotiating agreements with lenders to repay a smaller, affordable amount each month.
• Prioritising debts in terms of the consequences of not repaying and the cost of the borrowing (Annual Percentage Rate- APR and fees).
• Consolidating your debt into one loan.

Obtaining advice about debt, seek it if you need it

Free, impartial advice is available for borrowers from not-for-profit debt relief organisations. There are other organisations that offer advice for a fee. Paying a fee will reduce the amount of money you have to replay lenders, however it can can provide further support in the long run by creating a financial debt management plan.

Changing products

Once you know the repayments you can afford, you can consider:

• Changing their existing borrowing products for ones that cost less.
• Negotiating with their existing providers to extend the term of their loans.

You can approach your provider yourself or ask a debt adviser to negotiate on your behalf.

If you are struggling to repay a loan you may wish to consider extending the term of the loan. This is not always possible, but many providers would prefer that a borrower repay a loan in full over a longer period than not pay it.

Some of the factors to consider when extending the term of a loan or taking out a longer-term loan to repay an existing shorter one are as follows:

Practice Debt Management

Debt management plans are offered normally with a fee however, there are organisations that can do so without a fee.

The advantages of having a debt management plan:

• They combine the entire unsecured debt into one easy instalment.
• They save money on the high interest rates paid across multiple credit cards and unsecured loans.
• They are ideal if you are struggling to cope with multiple payments.
• They help to keep your finances organised.
• They help to prevent missed payments or over-limit penalties.
• Provide compassionate advisors who deal with each case with absolute professionalism and understanding.

Ask for help if you need it

Debt liabilities cannot be taken lightly, to ensure debts do not spiral out of control a debt management plan must be created and executed. Successful debt management cannot always be done alone, it is okay to ask for help. Free or paid for debt advice, can help you take charge of your debt, create a debt management plan to get you out of debt and put you on the road to financial recovery.