As you develop and implement your financial plan, its important to protect your finances from the negative impacts of unfortunate events. Risks such as stock market volatility, damage to capital assets (such as your house or car) can wreak havoc on your personal finances. A critical element of financial planning is the management of risk.
Why Managing Risk is Important
Everyday we are exposed to a variety of risks. These risks can include, financial loss from investing in the stock market, potential damage to your vehicle and health by operating a vehicle at high speeds and fire damage to your home.
A large unforeseen event, such as the above examples, has the ability to drain all of your financial resources, ruining your way of life and undermining your financial plan. Managing risk helps mitigate potential financial losses and ensures that our way of life can remain unaffected by unavoidable events.
What is Risk Management
Risk management is intended to provide financial security through the use of financial strategies, tools and services. These are used in the attempt to mitigate large financial losses if and when they occur. A comprehensive risk management strategy will include the consideration of personal, property and liability risks.
Personal risk management includes the potential loss of income due to injury, poor health and unemployment. Property risks includes the potential loss of value of assets due to fire, hurricanes, negligence and other uncontrollable events. Finally, liability risks include situations such as lawsuits and damage to other’s property or person due to negligence.
How to Manage Financial Risk
One of the most popular ways to manage financial risk is through the purchase and use of insurance. Insurance protects its policy holders from large and unexpected financial losses, by compensating them, per their contractual obligation. This form of risk management is often referred to risk transfer.
A second common way to protect against potential loss is risk avoidance. In life, many risks and their consequences are unavoidable, however we can choose to avoid some risks by making different choices in life. In example we can help avoid long-term health care problems by living an active and healthy lifestyle. In addition we can avoid devastating injuries by wearing seat belts.
Risk management is an important part of the financial planning process. Without the proper risk management tools you and your way of life are exposed to potential large financial losses.