Having risk management protects your money from any financial loss, and even help you minimize the loss.
Here is why risk management is the most important part in your financial planning.
Risk management is a systematic way to discover and resolve the risk that someone might face. It is a process of identifying, evaluating, managing and mitigating losses.
No one of us is immune to any financial risks including business, investment, and non-financial world.
We will meet risk whenever we make any financial decision or other activities to pursue our financial goals. Risk occurs when there is uncertainty in life. Therefore risk cannot be eliminated but can be managed.
If you were assigned suddenly to other cities by your office and needed to pay for the travel spending.
The office said would reimburse your expenses. Or if you were diagnosed with a serious illness that cost millions for treatment.
These are unpredictable events that would cost your budget if you did not have an emergency fund or travel insurance that is part of risk management.
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What Is The Purpose of Risk Management?
The main goal of risk management in financial planning is to protect your money from any financial risks.
They can be getting laid off from your current job, damage to a house or car, the death of a family member who supports you financially or having an accident that gets you hospitalized.
These unfortunate events may keep you from achieving financial goals or interrupting your financial plan unless you have risk management.
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Risk in Investment
“The essence of investment management is the management of risks, not the management of returns.”
In investment, risk cannot be separated from return.
Your investment decision involves some risk. When you decide to invest in P2P lending, the risk is that there will be someone who will fail to pay.
Knowing how a company manages this risk is important to know how much money you can lose, and what form of protection the firm give, besides understanding its business model.
In stock, investors treat a risk such as volatility in the market by diversifying their investment.
Understanding risk is crucial to help you manage the risk well. Failure to understand risk well lead to a negative impact on your investment outcome.
Everyone has a different type of risk when it comes to investing.
Some love challenges and are willing to take big risks, expecting to gain greater returns. But, some avoid risk because they prefer safety, though the return is relatively small. From your risk tolerance, that is how much risk you are willing to take, you can find out your risk profile.
You can find out your risk tolerance in investment from your age, status (single or married), amount of money, investment period, investment experience, and financial plan.
What to Prepare for Risk Management
As you know risk occurs because there is uncertainty in life that cannot be removed. But people can manage risk.
And you also can manage the risk that comes from these uncertainties to protect your financial plan and achieve your financial goals.
To prepare for risk management, someone will need financial planning, a positive cash flow, an emergency fund, and knowledge of insurance products.
Risk Management Process
Risk management process is ways that help you discover, and understand risk such as the size of each negative impact (how bad), the duration of the impact (how long), and the frequency of the impact (how often) a risk can bring, and then solve it.
In financial planning, this process includes risk identification, risk value measurement, risk control, and review of risk control.
Before deciding on the method to solve financial risks, you need to figure out what are the financial risks possibility to occur in your financial planning.
List these risks such as losing a job, home or car damage, death, or critical illness.
Then count the greatest amount of money you can lose from the risks. Measuring them helps you to know the right protection against the loss.
Example of Risk Identification
Doni has a wife and two little children. They bought a house, car, and motorbike 2 years ago. The total income of his family is Rp 20.000.000 per month. And the total spending on monthly expenses are Rp 10.000.000.
Now let us identify the likely risk Doni and his family might face.
Doni has a house, car, and motorbike. If Doni got an accident and had not had his car insured, moreover he still paid for the car’s installment, he would face a financial loss that lead to financial problems.
He might borrow money that caused him to add more debt. He also might need to minimize loss by cutting monthly spending.
Doni also has not got his house and motorbike protected by insurance. And he also still pay the mortgage bill.
Some of us does not protect our asset yet such as a fashion boutique or herbal shop.
The fact is, having insurance for property such as the store or house is important since it is the source of income.
Therefore to address this asset risk, Doni needs to buy insurance for all of his assets as protection.
Family Financial Support
Doni and his wife both work and thus have the income to support their children. If Doni got laid off from a job his family still has another income which is from his wife, even though the income was reduced.
For this risk, Doni can buy life and health insurance for himself, and his family as protection from unpredictable events.
So what are the risks that you have discovered in your financial planning?
Measure Risk Value
Risk value can be defined as the cost someone will pay when a financial risk happens.
When a car was damaged from an accident the cost of the repairmen is the risk value. The medical bill for a Covid-19 patient as well as home repairmen is also the risk value.
Example of Risk Value
Let us see the risk value from the case of Doni family.
Let us assume that Doni’s income is Rp 15.000.000 per month and his wife’s income is Rp 5.000.000 per month.
He is 35 years old. And he wants to give insurance protection that is affordable to his children until they finish school 20 years later.
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Using the income-based value method, the risk value is as the following:
R 20.000.000 x 12 month x 20 years = Rp 4.800.000.000. This means that he needs Rp 4.8 billion to protect his children education.
This risk value will change because of the inflation rate each year, income raise, recession, or other factors.
Therefore Doni needs to look for insurance products or other protection in an investment instrument that can give coverage of at least Rp 4,8 billion.
Now you have known how to calculate risk value, there are some ways to control risk such as accepting risk, avoiding things that may cause risk, and reducing or transferring risk.
The following is the risk mapping using the case of Doni.
The following mapping is only an illustration. You can create the map based on your financial condition and financial plan.
Review Risk Control
The next step is to review your risk control. Using the case of Doni, he needs money as coverage for his children’s education of Rp 4,8 billion.
He looks for insurance with a lower premium per month. And he found that the premium is Rp 2.500.000 per month.
Doni then gets a raise in salary. So he recounts again the coverage. It turns out that the coverage is Rp 8.000.000, so he needs to update his insurance plan.
This can be done by adding money for coverage or open a new insurance policy.
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Risk management is a systematic way to discover and resolve the risk that someone might face.
Risk occurs when there is uncertainty in life. We cannot remove risk but we can manage it.
Having risk management you will be confident and able to face any potential risk and protect your finance.
Have you prepared risk management for your finance in 2021? If you haven’t now is a good time to do that.
Contact one of our certified financial planner if you need consultation on creating risk management. Our financial planner is ready to help you.
Don’t forget to share this article and help people around you to face, and manage their financial risk.
- Risk Management 01 – https://bit.ly/38hantx
- Risk Management 02 – https://bit.ly/2LqZahj
- Risk Management 03 – https://bit.ly/3pUWW8C
- Risk Management 04 – https://bit.ly/2L5VvFK