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Financial Planning - Risk Management

While financial planning is about building wealth, it is also about risk management. With financial planning, risk management helps you decide on the type of investments you are comfortable with.

There are four different approaches that are used for risk management. The first one is risk avoidance. This may seem like a simple point, but it is a bit more complex. All risk cannot be avoided. It is necessary to make some decisions regarding which risks can and which cannot be totally avoided. It is possible, for example, to avoid the risk of losing your investment capital in the stock market by not getting involved in the stock market at all. You can avoid the risk of dying in a plane crash by totally avoiding flying, too. You cannot avoid the risk of illness or injury. These risks must be managed by other means.

When risk avoidance is not possible, the next approach is risk reduction. This is the most common type of risk management in financial planning. The entire area of insurance is usually involved here. Health insurance is not a way to reduce the risk of illness, but it certainly does that job for the financial consequences. The principle of risk reduction can be applied to investment also. There are some investments that feature a very low risk while others involve much more risk. Of course, the high-risk investments are going to be the ones that offer the best return. It is part of the financial planning process to decide how much risk is acceptable.

A third type of risk management tactic is risk acceptance. This involves the idea that a certain amount of risk is going to be present in any type of investment or even in living a normal life. Certain risks can be just assumed. This may seem a bit like gambling, and it is just that. However, in some cases the returns that can be realized by the acceptance of a little risk make it a good gamble. There is also no way that life, or even a business venture, can be made totally risk free. It is one of the key decisions in financial planning to separate the acceptable risks from the unacceptable ones and prepare accordingly.

The last type of risk management tactic is risk transfer. This almost always involves some type of insurance. This is actually a good way to see the way many types of insurance actually work. You are paying someone else to assume the major risks of your life or business. The process involves identifying potential risks and then deciding which ones are acceptable risks and which are not. The unacceptable risks are transferred elsewhere by procuring insurance. It is foolish to assume that all risks can be managed. Life was never risk free, nor will it ever be so, but with proper financial planning tactics, you can minimize

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