Life is inherently risky. We run the risk of something going wrong daily. Most of the time we can avoid risks by the good choices we make or by planning ahead. When it comes to our finances we can apply the same thinking. Many financial risks can be avoided by doing research and making wise decisions. However, some unpredictable things fall outside of our control. This is where risk management really comes into play. There is no way to eliminate all risks, but we can minimize and even circumvent many risks that could affect our financial security.
It’s all about your choices:
If you’re the kind of person that likes to take a little more risk in your life you may feel comfortable taking a walk during a thunderstorm, acknowledging that there is a chance of getting struck by lightning. But if you tend to avoid the riskier paths, you would probably stay inside during the storm where you know you will be safe. This same principle applies to our finances. There are some things we know will carry more risk than others, and depending on how well we tolerate risk we can either embrace that risk or avoid it. (You can read more about risk tolerance here).
There are different ways that we can approach risk:
When we assume risk we are not doing anything to minimize a potential loss. For example, if you don’t have car insurance and you get into a wreck, you will have to cover the full cost of damages yourself.
Sometimes we can share risk (also known as risk distribution) so that we don’t carry the full weight of potential financial burdens. If something bad happens, sharing the risk helps spread the effects and reduces the impact you may feel. This works well when you have a financial partner backing you.
We can transfer risk to others- like insurance companies- and they assume the responsibility (as long as you are paying your premiums). Insurance companies use the Law of Large Numbers and mathematical and statistical formulas (actuarial science) to assess risks they are taking on. We’ll talk more about insurance in our next article.
If we make efforts to avoid risks we can circumvent some problems altogether. Avoiding risk means you steer clear of choices that could lead you to potential problems. This can be a great way to prevent large losses, however, while avoiding riskier possibilities you might also miss out on other options and opportunities.
The whole idea behind risk management is to limit potential damage and protect your assets. If you have questions about risk management or any other financial concerns you can send them to qestions@yieldfa.com and we’ll write up a response!
“Think risk first, then reward.”
-Anthony M. Gallea
Pg.51 The Maxims of Wall Street by Mark Skousen