Mitigating Financial Risk: Strategies for a More Stable Future
Summary: Risk is an inescapable part of our lives, especially when it comes to our finances. It’s important to be prepared to identify, assess and control financial risk. Here’s a summary of some risk mitigation strategies you can rely on.
Although the risks that individuals encounter differ from those faced by businesses, the consequences of poor risk management can be just as significant.
Whether it’s a major investment that goes south or a sudden loss of income — financial risks have the potential to completely upend our lives. That’s why it’s critical to plan ahead for your financial future, by building effective strategies to help ensure your financial stability and resilience.
Understanding financial risk
Financial risks are events that can put a dent in your bank account, retirement savings and/or investments. Some risks are unexpected, such as job loss, prolonged illness, or disability. Others, such as market volatility and a poorly performing investments, are inbuilt risks.
As you progress through the different phases of your life — from getting an education, climbing the corporate ladder or preparing for retirement — financial planning and setting priorities makes it possible to achieve your goals. But in the process of planning, you inevitably address risks, whether consciously or unconsciously.
To establish long-term financial stability, it’s helpful to have a well-thought out risk management strategy based on each milestone in your life.
Types of financial risk
Here are the types of financial risks you need to be aware of and plan for:
Income risk: Income risk refers to the risk of losing your job, having your work hours reduced, or your business failing. Essentially, any event(s) that impacts your earning potential is an income risk.
Health risk: A health risk would be an unexpected illness, injury, or disability that prevents you from working and leaves you with costly medical bills.
Longevity risk: This is the risk of someone outliving their retirement savings or income.
Property risk: This refers to the risk that your property, such as your home or vehicle, will be damaged, destroyed, or stolen, causing undue financial strain.
Liability risk: This is the risk of facing legal action for causing injury or property damage to another person.
Mortality risk: This risk involves your unexpected death and what is left behind for your family to deal with, such as your outstanding debt and funeral expenses.
Investment risk: Most types of investment involve a certain amount of risk. If you invest in the stock market and it goes through a period of volatility, there is a risk that you could lose money with your investments.
The importance of financial stability
Many of the financial risks you face may be unexpected, so working to secure financial stability is key to getting through the uncertainties of life.
But what exactly is financial stability? In its ideal form, a financially stable person makes the right choices in spending and savings, for the present and the future, while managing risk.
This typically means that they:
- Have a reliable source of income
- Make and stick to a budget that is aligned with their income
- Practice responsible debt management
- Maintain a liquid emergency fund
- Save a portion of their income on a regular basis
- Build a targeted, diversified portfolio of investments
- Have adequate insurance coverage
Achieving financial stability requires prudent financial habits that have positive, far-reaching and long-term implications. And being financially stable has more benefits than enabling you to pay all your bills; it can also help your mental well-being.
Risk assessment: identifying and evaluating risks
It’s not possible to eliminate financial risk entirely from your life. However, there are strategies you can use to lessen the impact of those risks if and when they become a reality.
To ensure you are prepared, you must first identify the potential risks in your life, assess their likelihood of happening and evaluate their possible impact. Then, you can decide on effective mitigation strategies to help prevent or lessen the blow of those risks.
Part of a risk assessment is to also determine how much risk you are willing and able to tolerate. This will be different for each person, so the risk assessment and mitigation plan will look different for everyone.
For example, say you have a considerable amount of money invested in real estate. While the real estate industry may be strong now, it has had significant downturns in the past. After evaluating the history of the real estate market and the possible risk of a market crash, you may decide it’s wise to diversify your investments. This way, if the housing market does crash, the blow to your investment portfolio could be less severe.
Risk mitigation strategies in personal finance
Once you’ve identified and evaluated your risks, and determined your risk appetite, it’s time you to put risk mitigation strategies to work.
In personal finance as in the corporate world, there are five, broad risk mitigation strategies based on responses to risks:
- Avoidance: This strategy works by avoiding the source of a risk or completely eliminating exposure to it.
- Loss prevention and reduction: With this strategy, you implement measures to decrease the chances of the risk occurring.
- Sharing: By co-operating with another party or parties and distributing the financial impact of potential losses, you share the risk.
- Transference: This is a ‘pass the buck’ strategy in which you transfer the risk and its consequences to a third party via a legal agreement.
- Acceptance: Also called retention, this is accepting the inevitability of risk and learning to live with it.
Often the most overlooked element of risk mitigation is monitoring and reviewing risks, and taking corrective measures to tackle existing and new risks.
Here are some risk management principles to help protect your future financial stability:
Help protect yourself with insurance
Getting insurance coverage for your assets, such as your home and vehicle, is an important step to help protect you against financial risk. It’s even more important to get health and life insurance, so you and loved ones have a way to stay more financially stable in the wake of a major health event.
Finding insurance coverage is in line with the risk mitigation strategy of transference. In this case, you are transferring the risk to the insurance company. Adequate insurance coverage can help secure your finances from health, property, liability and mortality risks.
Build your savings
By saving up for retirement or for a rainy day, you can avoid or reduce your financial risks if you lose your job or experience a cut back in your hours. Having a 401(k), annuity or other retirement savings account can mitigate the impact of the longevity risk of not having sufficient assets to support yourself later in life.
Diversify investments
Putting all your eggs in one basket can put you at risk for significant losses in a downturn, so it’s advisable to diversify your investments. By doing so, your ‘healthy’ investments can help maintain some financial stability in case one asset class in your portfolio experiences a downturn.
Reduce debt
Accumulating large debt can pose a significant financial risk, by straining your ability to pay off bills in the long run. By taking concrete steps to reduce your debt, such as debt consolidation and downsizing, you can minimize the threat to your financial stability.
Retirement planning
Retirement planning involves accumulating sufficient funds so you can enjoy a comfortable quality of life on a stable income from guaranteed sources. By having different income sources such as Social Security benefits, taxable and tax-advantaged retirement accounts and informed asset allocation, you can tackle various risks such as market volatility, inflation and loss of income while building a lasting legacy for future generations.
Gain peace of mind with smart financial risk management
Risk represents both opportunity and danger. Your investments can be the key to long-lasting financial stability and a dream retirement, but an unexpected life event can throw your carefully laid financial plans into disarray.
To hedge against financial risk, you have to tread carefully and proactively. At Mutual of Omaha, our financial professionals can help set you on the path to better financial risk management for a sound, secure future.
FAQs
1. How do you manage personal financial risk?
The key to managing your personal financial risk is to be proactive and have a plan in place for when and if the unexpected happens. Carrying adequate insurance coverage for your home and auto can help protect you from risks to your personal property. Health insurance helps pay your medical bills if you are ill or injured. Having an emergency savings account can help out if you are ever at risk of losing your job or having your hours cut back.
When it comes to your investments, diversifying your portfolio is the best way to protect yourself from significant financial loss if there is a downturn in the market.
2. What is the first step toward managing risks?
Identifying the possible risks you may experience that can cause financial instability is the first step to take in managing risks and mitigating their impact. Once you know what you could be up against, you can better prepare yourself to deal with the risks you may encounter.
3. What is a risk assessment?
In a risk assessment, you identify the potential risks you may encounter, analyze the likelihood of them happening, and determine a strategy to minimize the damage.
Disclosures:
Registered Representatives offer securities through Mutual of Omaha Investor Services, Inc., Member FINRA/SIPC. Investment Advisor Representatives offer advisory services through Mutual of Omaha Investor Services, Inc.
Mutual of Omaha and its representatives do not provide tax and/or legal advice, and the information provided herein is general in nature and should not be considered tax and/or legal advice.
Not all Mutual of Omaha agents are registered representatives or financial advisors.