Preventing disasters is more than half of financial success.
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By Christine Benz | 07-30-09 | 06:00 AM | Email Article

At Morningstar, we firmly believe that the best investors are at least as attuned to the risks they're taking as they are the money they're making. For that reason, we've long preached the importance of having an appropriate stock/bond mix given your time horizon, the value of having durable holdings at the core of your portfolio, and the folly of dabbling in overly narrow, risky investments. We've often gotten guff from our readers for our caution, particularly when the market is going up. But we believe that Warren Buffett had it right when he said that the first rule of investing is to not lose money, and that rule number two is not to forget the first rule.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

In addition to managing the risks in your investment portfolio, it's also important to anticipate and troubleshoot other financial risks that might arise. Here's an overview of some of the key risk-management questions to consider. This is by no means an inclusive list, by the way; I welcome your feedback on other risks that you've identified and steps you have taken to protect yourself. 

Do You Have an Emergency Fund?
One of the fastest ways to start down the path toward financial ruin is not having a cushion to protect yourself against unanticipated events, such as losing your job, or unanticipated expenses like home and auto repairs or medical bills. For that reason, conventional financial-planning wisdom is to put three to six months' worth of living expenses in a highly liquid account such as a savings account, CD, or money market fund. Given the current economic climate,  however, I'd recommend building up a more generous savings cushion--six months' to a year's worth of living expenses, if you can swing it. This is particularly important if you are a higher-income earner, because it usually takes longer to find higher-paying jobs than it does those that pay less, or if you have any reason to believe that your job is in peril. Here are some details on setting up an emergency fund. 

Are You Protected Against Identity Theft?
Consumers have, thankfully, become much more attuned to the issue of identity theft. However, given the trying economic climate, I think it's safe to assume that identity theft could pick up in the months ahead. You can't be too careful about security when conducting transactions online, and you should get in the habit of shredding documents that include identifying information. (I'm admittedly paranoid, but I shred anything that comes into my house with my name on it.) For more tips on how to safeguard yourself against the risk of identity theft, read this article.

Do You Have Adequate Insurance?
When making insurance decisions, one of the best pieces of advice is to not insure yourself against risks you can afford to cover. For example, if you have ample savings, you're not going to be sunk if your computer goes kaput and you need to buy a new one. (Sorry, extended-warranty sellers at Best Buy.) On the flipside, you'll definitely want to insure against bigger, more costly risks. For that reason, you'll obviously want to have coverage for your home and autos, as well as good medical coverage. Also look into the following.

Life Insurance: If you're still working and have dependents, your largest asset is your own ability to produce income in the future. Thus, it's essential that you have adequate life-insurance coverage. And if your spouse stays at home and cares for the kids, you may also want to investigate life insurance for her/him. Life-insurance agents may disagree with me, but term insurance is often the most effective (and certainly the most cost-effective) solution for many individuals. If an insurance agent recommends a more permanent type of policy, make sure you thoroughly understand the reasons why he or she finds this type of coverage preferable to a term policy. (John Coumarianos covered some of the considerations for annuity buyers in this article.)

Disability Insurance: Fully one third of Americans between the age of 35 and 65 will become disabled for more than 90 days during their working careers. If you couldn't do without your income for an extended period of time, it's imperative that you purchase disability coverage. Your employer may offer cost-effective coverage; sign up to pay for it using aftertax dollars, meaning that your benefits will be tax-free.

Umbrella Policy: If you're a worrywart like I am, you'll find that personal liability insurance (an "umbrella" policy) is one of the most cost-effective ways to purchase peace of mind. These policies usually sit on top of your homeowners and auto policies, and cover you in case you're sued for an accident that occurs on your property. If you have contractors, housecleaners, babysitters, or dogwalkers on your property--and even if you don't--an umbrella policy is a must.

Long-Term Care Insurance: Not everyone needs long-term care insurance. Those with a lot of assets may be able to cover their own long-term care costs, and those with small portfolios may be covered by Medicaid. If you're over 45 and fall somewhere in the middle of that spectrum, however, you should investigate long-term care, because the costs of nursing home or in-home care can quickly gobble up your nest egg. I favor the policies that include inflation protection, though you'll pay more for that type of coverage.

A version of this article appeared on Morningstar.com on Jan. 29, 2009.

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