Sources of financial risk and possible solutions
Create peace of mind by understanding and managing your risk.
October 19, 2017 - Author: Terry Clark-Jones, Michigan State University Extension
Each of us desires the peace of mind that comes with knowing our financial situation and assets are protected from serious harm or loss. Let’s begin by thinking about the types of financial losses that we might experience and then look at the options available to us to reduce the impact of those losses.
The potential financial risk in our lives fall into several categories: illness or accident, legal liability, death, and property loss.
- Illness or accident- an increase in expenses due to high medical bills, treatments, and prescription costs, as well as the loss of income if you cannot work.
- Legal liability- having a legal suit filed against you.
- Death- Loss of household income, lack of funds needed to make monthly bills, and funeral costs.
- Property Loss – due to fire, theft, damage to car, or from a natural disaster.
There are four major ways to cope with threats to financial wellbeing:
- Avoid it- Do not own a car or a house; not owning property means you don’t have anything to lose. Also, avoid high-risk activities such as skiing or owning a trampoline.
- Reduce it- Maintain your property by keeping it clean and uncluttered. Install smoke detectors and bolt locks.
- Accept it – You may choose to self-insure for small losses.
- Transfer it – Acquire insurance for protection.
Here is an example on the steps to take for managing your financial risks. This is much like the process you would use in managing any part of your life. Let’s use the example of a car you own.
- Identify the exposures to risk. What is the value of your car?
- Evaluate the potential loss and severity of the loss. Are you a safe driver? Do you drive many miles in short amount of time? Do you drive in a high-populated location with many other drivers?
- Select a way to handle the risk by thinking through the four major options:
- Avoid it: Sell the automobile.
- Reduce it: Drive more carefully.
- Accept it: Have an automobile that is not worth a lot of money.
Choose not to carry comprehensive or collision insurance.
- Transfer it: Purchase auto insurance.
4. Implement the plan you have decided to follow.
5. Evaluate and adjust plan as needed.
Please keep in mind the following principles as you develop a risk management plan:
- Never risk a lot to save a little or risk more than you can afford to lose.
- Consider accepting financial impact of small risks but insure against major risk.
- The goal of risk management is to protect the resources and assets you have from the possibility of financial loss.
- Your personal risk management plan will develop out of your personal financial situation.