The Importance of Personal Financial Risk Management
Companies and investors talk about risk all the time. But did you know that risk is something you should worry about with your own personal finances as well?
Risk is not something to be concerned with only for those business professionals or wealthy types. Everyone has some risk involved in their finances. Most, however, don’t think they should have a management plan in place for that risk because they don’t make enough.
But, a plan to manage your risk can be beneficial especially when investing in your retirement or for more immediate expenses.
Keep reading to learn why having a plan for managing risk is important for your personal financial health.
What Exactly Is Meant by Risk?
Risk is defined as the possibility of loss. In the case of financial risk, that loss can be nearly noticeable to crippling. It all depends on the amount of risk you’re willing to take.
Risk can’t be removed completely, but it can be mitigated. However, the first step to doing this is knowing the four types of risks.
Pure risk is a loss that is possible only after an event has actually occurred. This form of risk is pretty straight forward without any gray area. An example of a pure risk would be your car is either totaled or it is not. Usually this type of risk is insurable.
This type of risk is different from pure risk because it could result in either a loss or a gain, or no change at all. There is more room for gray here and also a higher risk factor. A great example is investing. The more money you invest the higher your potential rewards or losses. The more you invest the higher your risk. Generally speculative risk is uninsurable.
Income risk affects your income. This can be through loss of a job, death, injury, etc. Anything that can affect your income in a negative way.
Expense risk is when you are spending more than you are making. Your debt to income ratio is high and you run the risk of running out of money. This risk usually means you don’t make enough money to support your lifestyle, or in the eyes of creditors you aren’t managing your money well.
As mentioned earlier, there is no way to truly eliminate all risk. However, you can mitigate risk through risk management. Managing your risk has many benefits.
The first benefit of managing your risk that it allows you to better prepare for the unexpected. Often times losses occur because risks that aren’t easily apparent are overlooked. This can lead to surprises and your bank account can suffer for it.
Another benefit to having a plan for managing your risk is the ability to appease creditors and lenders. When it comes to obtaining credit or loans lenders can be stingy. After all, they want to make sure they get their money back.
A good way to ease a lenders mind is to produce a risk management plan. You’ll be able to show the lender the compensatory measures you have in place in case of a surprise or event.
There are four methods for managing risk.
- Assume the Risk – You don’t do anything to lessen the impact of the loss. You’ve made your choices and you know the consequences.
- Avoid the Risk – This is usually done with insurance agencies. Something like lower rates for a clean driving record. You avoid risk by being a better driver.
- Share the Risk – The loss is shared by all involved. For a household with two incomes, the loss of one income means the other picks up the slack and shares in the loss.
- Transfer the Risk – This is someone else’s problem. Literally, you’ve made it their problem. In terms of insurance the agency will pay the cost of the loss for a monthly premium fee.
Managing Your Personal Financial Risk
Managing the risk for your personal finances will save you greatly in the long run. Being able to identify risks before they become problems, as well as show creditors how you plan to manage any potential loss, will help you to achieve your financial goals.
Don’t fall victim to easily mitigated risk. Manage your risk today with an effective management plan.