Risk is uncertainty.ย Risk is the variability around an expected outcome. The larger the variability, the higher the uncertainty, the larger the risk. Risk is pervasive. Most activities involve some sort of risk. Accepting risk involves nothing more than a cost-benefit analysis. We choose to accept risk because we see the benefits as outweighing the cost.
Adverse decisions in accepting risk can be due to a number of things including influence of substances, lack of information, lack of understanding, lack of judgment or the existence of emotional factors.
We must accept some risk.ย Risk is expensive. The purpose of risk management is to minimize this cost. What will give us the most value for our dollar in the cost benefit analysis of risk?ย This is the goal of risk management.
Our aim in financial planning is to manage individual, personal risks. Personal risks involve risk exposures that reduce our individual wealth. These include: liability risk, income risk, longevity risk, asset risk and medical risk.
Below are a description of risks with common ways of managing them.ย The primary purpose is to provide a brief description and show you where to find more information on the managing of this particular risk.ย There are multiple ways of managing most risks, risk transfer is one way.ย Insurance is a form of risk transfer.
Liability Risk:
Risk of being sued for damages to others.ย Managed through liability insurance.
Income Risk:
Losing job, losing family breadwinner, losing ability to work (i.e. disability).ย Managed through life insurance, disability insurance, social programs, etc..
Longevity Risk:
Outliving finances.ย Covered through proper retirement planning and effective use of assets during the lifetime.
Asset Risk:
Losses to monetary and physical assets (house, car, investments, retirement).ย Protection of physical assets are covered under property insurance, i.e. renter’s, homeowner’s, or auto insurance.
Medical/Health Risk:
High medical costs.ย Covered through health insurance.
These are the risks that we manage through financial planning.ย Business risks have similarities, but are also very different.ย In addition to the above, there are many ways to reduce risk in both frequency and severity.
