Risk management in financial planning is the systematic way of the discovery and treating risk. The aim would be to minimize worry by dealing with the possible losses before they happen. - invest
The process involves:
Step one: Identification
2: Measurement
3: Method
Step 4: Administration
Risk Identification
The method begins by identifying all potential losses that induce serious financial problems.
(1) Property Losses - The direct loss that requires replacement or repair and indirect loss that will require additional expenses due to the loss.
(For instance, the damage from the car incurs repair cost and further expenses to rent another car as the car has been repaired.)
(2) Liability Losses - It arises from the damage of other' property or accidental injury to other people.
(For instance, the harm to public property due to an auto accident.)
(3) Personal Losses - Losing earning power as a result of death, disability, sickness or unemployment and the extra expenses incurred as a result of injury or illness.
(For example, losing employment due to cancer and also the required treatment cost as well as normal bills.)
Risk Measurement
Subsequently, the maximum possible loss (i.e. the severity) linked to the event plus the probability of occurrence (i.e. how often) is quantified.
(1) Property Risk - The replacement cost necessary to replace or repair the damaged asset is estimated with a comparable asset in the current price. Indirect expenses for alternative arrangements like accommodation, food, transport, etc, must be taken into account.
(2) Liability Risk - This can be regarded as being unlimited since it will depend upon the severity of the event and the amount the court awards towards the aggrieved party.
(3) Personal Risk - Estimate the present value of the required bills and extra expenses each year and computing it over a predetermined period of time at some assumed interest and inflation.
Types of Treating Risk
A combination of any several techniques are utilized together to deal with the risk.
(1) Avoidance - The complete removal of the activity.
This is the most effective technique, but the most difficult and may sometimes be impractical. Additionally, care has to be taken that avoidance of just one risk doesn't create another.
(As an example, to avoid the risk associated with flying, never take a flight on the plane.)
(2) Segregation - Separating the risk.
This is a simple technique that involves not putting all your eggs in a basket.
(For example, to avoid both mom and dad dying in the vehicle crash together, travel in separate vehicles.)
(3) Duplication - Convey more than one.
This method requires preparation of additional support(s).
(As an example, to avoid losing use of a vehicle, have Two or more cars.)
(4) Prevention - Forestall the risk from happening.
This technique aims to reduce how often of the loss occurring.
(For instance, to stop fires, keep matches from children.)
(5) Reduction - Minimize the magnitude of loss.
This method aims to lessen loss severity and could be used before, during or after the loss has occurred.
(For instance, to reduce losses as a result of a hearth, install smoke detectors, sprinklers and fire extinguishers.)
(6) Retention - Self assumption of risk.
This system involves retaining the danger consciously or even more dangerous as unconsciously to finance your own loss.
(As an example, having 6 months of revenue in savings to guard against the chance of unemployment.)
(7) Transfer - Insurance.
This technique transfers the financial consequences to a new party.
(This can be covered in greater detail as a topic.)
Administration Of Method
The selected methods has to be implemented.
And finally to close the loop for the process, new risks should be continually identified and all risks needs to be re-measured when needed. Treatment alternatives also need to be reviewed. - invest