Risk management is a key component of your financial planning.
What is Risk Management?
Risk Management is an important yet sometimes overlooked aspect of personal finance. By definition, “risk management is the process of understanding, analyzing, and addressing potential risks to ensure objectives are achieved”. Risk means variability and unknown outcomes. In terms of your financial situation, a risk management strategy should align with your goals and your risk preferences.
Developing a risk management plan for both corporate and personal finance is an important part of a balanced portfolio. A corporation may manage their risk by instituting a succession plan. However, someone looking to manage the risk for their personal finances needs to consider a variety of situations which could result in financial loss.
What Are the Different Types of Risk?
There are a wide variety of risks that families and businesses are exposed to such as inflation, unforeseen medical expenses, and longevity risk. These three main types of risk are commonly addressed with a risk management strategy:
1. PURE RISK
This type of risk is usually insurable and is usually caused by a specific event such as a house fire. This is an involuntary risk, but you can take action to hedge your level of exposure to this type of risk.
2. SPECULATIVE RISK
This is a voluntary risk and can result in a gain, loss, or no change at all. While no one can predict the future, an experienced financial advisor can estimate the probability for gain or loss and choose investments that align with your risk profile and goals.
3. INCOME RISK
Income risk is the risk that your yield from an investment will decrease due to interest rate fluctuations. There are a variety of techniques to mix fixed and variable interest rate products to combat income risk.
How to Create a Risk Management Strategy
Generally speaking, when creating a risk management plan you need to start by identifying the nature of the risk and identifying how much risk you’re willing to take. A thoughtfully constructed plan can help you to avoid or mitigate unwanted risk. It’s vital to re-asses your risk management plan on a regular basis to ensure it is protecting your needs as your life and risk tolerance changes.
Risk is not necessarily a bad thing, so long as it is coordinated risk that you are well prepared for. In order to create a comprehensive plan for your specific risks you should consider these different strategies:
- Risk Avoidance
- Risk Retention
- Risk Reduction
- Risk Sharing
- Risk Transfer
In addition to the formal strategies aforementioned, there are some important things you can do to help you create your risk management plan. Understanding your financial risk, having a balanced portfolio that fits your risk profile, and having proper insurance can help you address your risk needs.
Understanding risk management and planning your financial strategy can give you peace of mind and allow you to better control your finances in an uncontrollable world. Brentwood Financial Advisors is here to help you with your financial needs. Our range of services and experienced advisors are dedicated to help you reach your financial goals and attain your desired future.
Contact us today to review your financial goals.