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Sometimes we underestimate risk, and pay a heavy price

LiveMint logoLiveMint 05-03-2017 Rajiv Jamkhedkar

People crave ‘financial security’. The term can mean different things to different people but essentially we understand this intuitively. It is the first step towards ‘financial well-being’.

What people underestimate all the time are the factors that can cause the status of a family to change from being financially secure to being in financial distress. Such disaster scenarios can occur in any family. Yet, our perception of these risks is such that we think the chances of such events happening to our family are very low.

Death of an earning member is a case in point. This is also the most obvious and commonly played-out scenario in India. Life insurance can help the surviving family. Yet, in 90% of the cases, the insurance amount is too small to take care of the families’ needs. I have come across hundreds of cases where the person who died was insured for less than Rs10 lakh. In today’s time, how many months can this sum of money last for a family of four?

Chronic illness, or a major disease, afflicting any family member can also change the family’s status from being secure to being in distress. Cancer, kidney failure and neurological disorders are examples of illnesses that are long-drawn affairs and entail expensive treatments. I know of two middle-class families that have had to take huge loans to pay for the treatment of such illnesses.

One in two Indians are likely to face some critical illness in their lifetime. And, we are living longer and the probability of lifestyle diseases is also high.

Yet, the common salaried person’s perception of these risks is often puzzling. People do not believe that these are high-risk probabilities. One person, a 35-year-old successful management consultant, earned a high income, had a flat in a nice suburb and lived an enviable lifestyle. But one day, he had a heart attack. Along with the burden of treatment costs (he had to undergo major surgery), he lost his job as well.

He had to liquidate his savings and fixed deposits, and still did not have enough to pay all the medical bills. He had to borrow from friends and family. Financially, this has set him back by 5 years.

An assumption that many people have is: “I have a nice job, a good salary, a reasonable lifestyle... I don't have to worry about money.” Well, don’t be so sure. Today’s corporate world is extremely competitive and job losses can happen even to people who have spent a loyal 20 years at one company.

Another person, a client of mine, lost his high-paying job overnight. There were loans and monthly bills to pay for. For a good 6 months, money was an issue and a lot of valuable shares had to be sold off to pay for immediate expenses. So, why is it that we are unable to properly calculate the perceptions of risk?

First, when thinking at an intuitive level only, human beings are poor calculators of probability. There are several psychological factors that account for this. Our minds are more led by stories and anecdotes, instead of data. Our minds will overestimate risks that are accompanied by some ‘plausible story’ and underestimate risks that are not in our immediate domain. For example, earthquakes and cyclones often cause severe property damage in many parts of our country and yet people’s perception is that this risk is minuscule. 

I did a small survey of my friends (living in flats in Gurugram) and asked them this question: “Has anyone in your housing complex suffered a loss because of fire or theft in the past 1 year?” To my utter surprise, in the small sample that I surveyed, the answer was four houses. This meant, I was underestimating this risk (of loss due to fire or theft) in supposedly well-guarded, secure housing societies.

Many times, risks occur because of our misplaced confidence in our assumptions. The idea of a regular monthly salary is one such example. An antidote to this misplaced confidence is to ask: “What if this isn’t so? What will happen if my assumption is wrong?What will happen to my financial future if I do not get any salary raise or bonus for the next 5 years?” And this actually happened to many professionals working in the US after the financial crisis. 

What are some steps that one can take to prevent financial distress?

Get appropriate insurance: Life insurance, hospitalization insurance, critical illness, and insuring your property against earthquake, fire or other calamities. This depends on the individual and should be done sensibly. Right insurance products must be bought to cover the right risks.

Emergency funds: Keep some liquid funds to be used only in case of emergency situations in the family. This gives peace of mind and a buffer against misfortune that can strike anytime. 

Ask yourself “What if this isn’t so? Challenge your assumptions to understand the risks you are exposed to. 

Understanding risks properly is the first step to protecting oneself from them, when they occur.

 Rajiv Jamkhedkar, founder and managing director of Serengeti Ventures Pvt. Ltd.

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