Rising Above Risk
The word risk evokes a negative connotation in almost everyone’s mind. In Personal finance the word Risk need not necessarily mean negative.
What is risk? It is that part of our life that we are unsure about, which cannot be predicted accurately, an unknown or an undefined phenomenon. Every phase of our life is filled with it. You go to office and carry the risk of not getting on your bus, which means you run the risk of running late. Although we can roughly predict the consequences or happenings we can never give a guarantee that “this” will happen and “this” will not happen. This is called Risk.
So the same logic can be generalized for all things relating to our personal finance. The threat here will result in loss/gain of money and hence the importance given to the concept of Risk in personal finance is all the higher. There are innumerable risks that we face in our challenge to manage our personal finance.
Not getting returns as much as expected
Menace of having to pay a higher tax because of some sudden income
Chance of our bank closing down
Not getting a dividend declared by a fund due to postal delays
Rate of interest on housing loans going up after RBI announcements & Increase in EMI
The bottom line being that every financial transaction irrespective of the value or instrument carries a risk.
That puts us in a dicey spot (pun unintended). What do we do then? It’s so scary to think of transactions with all that danger inherent. Or is it? The answer lies in an old adage. Knowledge is power. The knowledge of being aware that there is an element of risk, irrespective of what that risk is. When you know that scenario A as well as Scenario B can happen, you can plan.
Risk planning is the term that your financial planner will use. Planning cannot remove the risk, but, it can ensure that the unpleasant effects of peril are mitigated or eliminated if possible. Since personal finance is all about money, proper risk planning can eliminate almost all ill-effects.
How is risk planning done? The first step to planning is to evaluate it. To know what is the exact risk that’s present in the given situation. It involves trying to predict the extreme effects of every risk happening. Meaning for example, the extreme danger in an investment is losing all the money invested. Once we are sure about the extent of possible hazard, we can arrange for alternatives, which will kick into play when the undesired part of risk takes place.
A more common term for managing risk is what we call Insurance i.e. insuring oneself against risk. For example, let’s say you lend Rs. 10 Lakh to a friend. The risk you carry is that he may not repay the amount. A risk mitigating tool would be to take a parallel agreement in which he transfers right to his property in your name in case he does not pay up. Although the example is a very extreme case which may not be applicable among close friends, this is what has led to what we call – Mortgage loan.
Know risk, no risk goes the common line. All the best.