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Course: Financial Literacy > Unit 6
Lesson 1: What is risk and how to manage itRisk management
There are four main strategies for managing risk: avoiding, reducing, retaining, and transferring. Each of these strategies has its own advantages and disadvantages, and the best approach will depend on the specific situation.
What is Risk Management?
Risk management is the process of identifying, assessing, and taking steps to minimize or eliminate the risks that we face in our daily lives. There are four main strategies that we can use to manage risk: avoiding, reducing, retaining, and transferring.
Each of these strategies has its own advantages and disadvantages, and the best approach will depend on the specific situation. In this article, we will explore each of these strategies in more detail and provide examples of how they can be applied in different scenarios.
Avoiding Risk
The first strategy for managing risk is to simply avoid it altogether. This can be done by choosing not to engage in activities that are risky, or by taking steps to prevent risky situations from occurring. For example, if you are concerned about the risk of getting into a car accident, you might choose to walk or take public transportation instead of driving.
Advantages
- Avoiding risk is the safest option, as it eliminates the possibility of loss or harm altogether.
Disadvantages
- It may not always be possible or practical to avoid risk. For example, you might not be able to avoid driving if you live in a rural area without access to public transportation.
- Avoiding risk can also limit your opportunities and prevent you from taking advantage of potentially beneficial situations.
Reducing Risk
Another strategy for managing risk is to take steps to reduce the chance or impact of a potential loss. This can be done by implementing safety measures, using protective equipment, or taking other precautions. For example, you might choose to wear a helmet when riding a bike or to install smoke detectors in your home to reduce the risk of injury or fire.
Advantages
- Reducing risk can help to minimize the potential for loss or harm, without completely avoiding the activity or situation.
- This strategy can be more practical and realistic than avoiding risk altogether.
Disadvantages
- It may not be possible to completely eliminate the risk, even with precautions in place.
- Reducing risk can also require an investment of time, money, or effort.
Retaining Risk
The third strategy for managing risk is to retain it, or to accept the possibility of loss or harm and be prepared to deal with the consequences. This can be done by setting aside money in an emergency fund, or by developing a plan for how to handle a potential loss. For example, if you work for yourself, you might save money in case you don't have a lot of work or if a project gets cancelled. This way, you can still pay for things you need even if you don't have a lot of work.
Advantages
- Retaining risk can allow you to take advantage of potentially beneficial situations, without avoiding or reducing the risk.
- This strategy can also be more cost-effective than transferring risk, as it does not require you to pay for insurance or other forms of protection.
Disadvantages
- Retaining risk means that you will be responsible for dealing with the consequences of a potential loss or harm.
- It may also require you to have access to financial resources or other forms of support in order to cope with a potential loss.
Transferring Risk
The final strategy for managing risk is to transfer it to someone else, typically through the use of insurance or other forms of protection. For example, you might choose to purchase car insurance to transfer the risk of an accident to the insurance company.
Advantages
- Transferring risk can provide you with financial protection in the event of a loss or harm.
- This strategy can also help to reduce your overall level of risk, as you will not be solely responsible for dealing with the consequences of a potential loss.
Disadvantages
- Transferring risk can be expensive, as you will need to pay for insurance or other forms of protection.
- It may also not be possible to transfer all of the risk, as insurance policies often have exclusions or limitations.
It's important to remember that not every situation will have all four risk management strategies available. Sometimes, it might not be possible to avoid or reduce a risk. For example, if you live in an area with a lot of earthquakes, you can't avoid the risk of one happening. You can reduce the risk by making sure your house is built to withstand earthquakes, but you can't completely get rid of the risk.
Also, some strategies might not be practical. For example, quitting your job to avoid a risk might not be something you want to do or can afford to do. It's important to think about what strategies are available and practical for your situation before you make a decision.
Want to join the conversation?
Less of a question, more of a general comment, but insurance on things like your life and car and stuff seems a bit riskier than just having a backup plan or emergency fund. If there's anything to be learned from this course it's have money in lots of places. From what I can tell, credit is a way to reduce risk. But, can savings be considered insurance? Like insuring yourself? That's all.(11 votes)
Insuring yourself certainly seems to make sense, because by doing so you don't "waste" the money you spend each year to have a company take the risk. For example, I pay about $1,600 every year for auto insurance, and if nothing goes wrong, I don't get a penny of it back. BUT, if I run you over, someone is going to have to pay a lot MORE than $1,600 for your medical bills. I'd rather that the insurance company, which has a lot of money, paid those bills. You'll be happier, too, because if I insure myself, then after I run out of money, your medical care stops.(14 votes)
What is retaining risk?(2 votes)- Financial life involves taking risk. If you keep your money in glass jars buried in the back yard, you risk others digging it up. If you put your money into the bank, it is safer, but there is still some small amount of risk. If you invest in the stock market, you have a chance of better return, but also a larger risk of loss.
To "retain risk" means to leave your money in an investment or bank where it can be lost.(4 votes)
What are the different types of risk mangements(2 votes)- Weren't those described in the lesson? Perhaps you should listen or read again.(1 vote)
- what is retaining risk?(1 vote)
- I answered that for someone 21 days ago. Set the "sort by" box for "recent", then scroll down. You'll find it.(1 vote)
What is retaining risk?(1 vote)- Retaining risk means that the chances you will lose something are yours. Insuring against risk means that you transfer those chances to someone else, but you pay them to take that off your hands.(1 vote)
- What is retaining risk?(1 vote)
- I answered that for someone not long ago. Set the "sort by" to "recent", then scroll down. You'll come to it soon.(0 votes)
how do you prevent a financial risk?(1 vote)- You prevent financial risk by finding a convenient cave and hiding in there for the rest of your life. Apart from something like that, you are always at risk.(0 votes)