The Amateur Financier

Risk is an unavoidable part of life.  No matter you do, no matter who you are, there is always the chance that your life will take an adverse turn.  Some of the risks that you will experience have a small potential loss (the risk that your digital camera will break, for example) while others have a the potential for great loss (the risk that you will experience a catastrophic injury and be unable to work).  Similarly, the chance that these adverse events will occur will vary, according to the type of risk, the precautions you have taken, and your own actions.  (For example, your risk of being injured in a motorcycle accident can be greatly reduced, if not eliminated, by not riding on a motorcycle.)  For a more comprehensive view on risk management, let’s look at four examples:

Less Severe, Low Frequency Risks

Example: The risk that your brand-new digital camera will break during the first year of ownership.  (Low risk because digital cameras are not very expensive, low frequency due to the (hopefully) high-quality nature of the camera.)

Best Strategy: Retain the risk; simply be aware that the risk exists, and take steps to prepare for situations where the risk can occur.  (With our digital camera example, have some funds set aside to buy a new camera, should it break and you need a new one.)

Less Severe, High Frequency Risks

Example: The risk that you could lose your golf balls while playing golf.  (Low risk as golf balls are fairly inexpensive (most of the time), high frequency as many amateur duffers have a tendency to lose their balls regularly.)

Best Strategy: Reduce the risk; cut down the frequency of loss if possible (in this case, by practicing your drives, for example) and minimize the monetary extent of the losses as much as possible (using cheap golf balls until you get better at the game).  If it’s impossible to reduce a particular risk, then simply be aware of the risk and take steps to retain the risk yourself.

More Severe, Low Frequency Risks

Example: The chance that you could contract a serious disease like cancer.  (More severe due to the fact that you could be facing huge monetary and health losses, low frequency due to the small statistical probability of getting most serious diseases.)

Best Strategy: Transfer the risk; these circumstances are the perfect situation where getting insurance to prevent huge monetary losses makes sense.  Health insurance for serious disease treatment, life insurance to protect your family if something bad should happen to you, and property insurance to protect your possessions all can be good choices for your circumstances.

More Severe, High Frequency Risks

Example: The risk of death or injury while sky-diving blindfolded during a thunderstorm (More severe due to the possibility of death, and high frequency of getting injured during the process.)

Best Approach: Avoid the risk; in situations where there is a high chance for devastating losses, the best course of action is to avoid the situation all together.  (If avoiding the risk is impossible, the next best solution is to reduce the risk as much as possible.)

A quick guide to all the situations discussed above can found in the graphic below:

I hope this quick guide to risk management planning has been helpful to everyone.

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