Risk Management - The “What If” Plan
The term Risk Management if often inferred as a strategic ‘business plan’ to identify and mitigate risks ensuring you successfully achieve your business objectives.
What about your life goals? What if we could prepare for the ‘What If’ moments of life?
From an individual point of view, the purpose of risk management is to secure your personal well-being, goals, aspirations and resources from the unforeseen uncertainties in life. Just like risk is a part and parcel of our daily lives, it is present in the world of finance and investments as well. The correct strategy is to understand the various risks and find ways to mitigate them and not to turn a blind eye. If we do the latter, its a recipe for disaster. A comprehensive financial plan must involve foresight to manage uncertainties; this is where risk management comes into play to protect your portfolio of investments. So how does one mitigate future unforeseen risks?
Actually understanding the different types of risks associated with your investment and how it may impact your portfolio. Prudence in assessing your risk tolerance level and investing accordingly can help you achieve your financial goals.
Vulnerabilities & Threats
Begin by identifying your vulnerabilities. Take into account your lifestyle, health, debt, income generating capabilities, expense track records, etc. Find out your weaknesses that could be a threat in case of any unforeseen occurrences. For instance, you have loans to pay off, the EMIs for it is equivalent to 30% of your current income. Here the threat of job loss could make you vulnerable to financial instability in the future.
Next, consider your capabilities to handle risks. In case of job loss, do you have enough saved in an emergency fund to ensure your essential expenses are covered for the next 6 months? Are you susceptible to any health issues or illnesses, how can you avoid this risk through a healthier lifestyle or manage it through insurance coverage, etc.
Once you have a basic understanding of your strengths and weaknesses you are now ready to deal with risks and decipher what risks you are willing to take and which risks you need to mitigate / prepare for.
Risks can be broadly divided into 5 categories namely Income, Expenses, Debt, Investments & Legacy. Let’s dive deep into each of these categories:
1. Income: Here the risk involved is the gap or inability to earn an income. A loss of job, disability or death of bread-winner, lack of savings before retirement, high-lifestyle expenses, etc. could be the reason for a loss in income leading to financial struggle. To avoid such a possibility as an investor you could create alternate sources of income to mitigate the risks of income loss from one source. Simultaneously, you could opt to mitigate the risk by investing in life or health insurance which could respectively replace your income or expenditure in your absence.
2. Expenses: Risks in expenses could be divided into controlled and uncontrolled expenses. Living a lifestyle, the expenses of which exceed your income capability is a controlled risk that can be curbed by cutting down on unaffordable luxuries. The uncontrolled expenses are usually unexpected events like an accident that totalled your car or unavoidable and expensive home repairs, etc. Proper planning can ensure your expenses are in-check and are well within your income capabilities. Investing in the right insurance (like car insurance) can safeguard you from unexpected expenditures.
3. Debt: The understanding of good and bad debt is vital to avoid an accumulation of excess debt. Overspending, accumulation of bad debts, excessive credit card usage, high interest loans, etc. are some of the reasons for debt risk. Unfortunately, there is no possibility to transfer such risks to insurers. As an investor one must ensure the risk of debt undertaken is for good debt. Good debt implies investing in an asset that will appreciate. Taking a loan to claim taxation benefits, while securing the ability to pay it back, is good debt. Taking a personal loan for an international trip is precisely what bad debt is. It is best advised to clear all debts before you begin investing for future goals.
4. Investments: The term investments stand for both investing in financial instruments and assets. Each of these investments will have its own attached risks. For physical assets risks like depreciation, damage, natural disasters, malicious acts, etc. are to be considered. Such risks can be protected with the appropriate insurance coverage. Investment risks include lack of prudence in savings, low retirement corpus, lack of diversification, volatile market scenario, loss of principal invested, etc. These investment risks can be curtailed with proper goal-based planning and investing. The correlation of assets, the need for diversification, goal-driven investing and risk management can guarantee that you stay on track to achieve your set financial goals. Assistance from experienced advisors like Alphabet Investment can go a long way to help you achieve your financial goals seamlessly.
5. Legacy: A major issue not discussed often enough risk of money ending up in the wrong hands or heirs having to struggle endlessly with red tape to get what is rightfully theirs. It is essential that assets are transferred risk free to the next generation. This can be done via estate planning. It is also preferable to have investments with a nomination to ensure investments end up in the correct hands
One must not be an Ostrich with its head into the sand avoiding potential dangers. One must embrace and understand risk which are life’s reality and an important component for better gains. Even the market has proven higher the risks, the better the potential gain. Prudence in life gives you the ability to better understand your capabilities and risk capacity thus allowing you broader possibilities to better gains. It is up to you to make the right choices and safeguard your valuable investments from the risky ‘What If’ situations.
Does your financial plan include a ‘What If’ plan sketched out to ensure you are guarded against the uncertain risks that life poses? Contact Us to know more about personal financial risks and how to manage them.