Risk Management in Personal Financial Planning

Risk management is a strategy for protecting assets and people. It reduces financial losses caused by destructive events. Understanding risks and how to manage them enables you to provide better protection for oneself and your family. That’s if you have dependants.

The most common risks are grouped into personal risks, property risks, and liability risks.

  • Personal risks are uncertainties surrounding loss of income or life due to premature death, illness, disability, old age, or unemployment.
  • Property risks are the uncertainties of direct or indirect losses to personal property due to accidents, fire, thefts, and other hazards.
  • Liability risks are possible losses due to negligence resulting in bodily harm or property damage to others. Such harm or damage could be caused by a vehicle, professional misconduct, injury suffered on one’s property.

Affording to cover all risks may not be feasible but understand how to obtain the best and affordable protection.

Risk Management Techniques

Here are four general techniques commonly used:

Risk Avoidance

People can avoid risks such as not smoking or not walking through high-crime neighborhoods. Risk avoidance is practical but no person can avoid all risks.

Risk Reduction

Avoiding risks completely is not possible but reducing risks is a possible action. For instance you can reduce the risk of destruction of property and loss of life in a house by installing smoke detectors and fire extinguishers. You can also reduce the risk of theft of your household property by installing burglar proof in your house or hiring armed security personnel.

Risk Assumption

Assuming risk means taking on responsibility for the loss or injury that may result from it. Generally, it makes sense to assume a risk when the potential loss is small, when insurance coverage is expensive, when risk management has reduced risk, and when there is no other way to obtain protection.

For example, you might decide not to purchase household contents insurance. Then, if theft occurs, you will incur the costs of replacing the things stolen.

Risk Transfer

This is the most common method of dealing with risk whereby risk is transferred to an insurance company or other organization.

Basic Risk Measures to Consider

According to financial planners, a basic risk management plan must include measures to reduce:

  • Potential loss of personal property due to fire, theft, or other hazards.
  • Additional expenses due to the injury, illness, or death of other family members.
  • Potential loss of income due to the premature death, illness, accident, or unemployment of a salaried person.
  • Potential loss of income and extra expenses resulting from illness, disability, or death of a spouse.
  • Potential loss of income, savings, and property due to personal liability.

Articles on Risk Management & Insurance