Ways to manage financial risk
About this video
The video explains three ways to manage risk: avoid or reduce it, retain it (and prepare with savings), or transfer it to someone else, usually through insurance. It applies these to two examples, losing your income and being sued for liability after a car accident.
You'll be able to
- name the three main ways to manage risk: avoid/reduce, retain and transfer.
- give an example of each strategy for loss of income and for liability.
- explain why insurance is a way of transferring risk.
Key words
- Avoid or reduce risk
- Taking actions that make a bad event less likely or less harmful.
- Retain risk
- Accepting a risk yourself and preparing to cover the cost, usually with savings.
- Transfer risk
- Paying someone else, like an insurance company, to take on some of the cost if something goes wrong.
- Liability insurance
- Insurance that pays, up to a limit, if you are found responsible for harming someone.
- Living below your means
- Spending less than you earn so you can save and need less to live on.
Transcript
- So let's talk a little bit about the different ways that you can manage risk. And it's generally gonna fall into a few categories. You can obviously try to avoid the risk altogether or reduce it. You could say, "All right, that risk is there and I'm gonna retain the risk.
And then how can I manage that?" Or you can actually transfer that risk to someone else. And we're gonna talk about all of those. So let's just pick a particular type of risk. Let's just say, one risk, one financial risk is your loss of income. What happens if you lose your job?
Or if you run a business, what happens if the business goes under or it has lower income for some period of time? Well, the first strategy is obviously to avoid that as much as possible or to reduce the probability of that as much as possible. So if you're at a job, try to perform well at your job so if they're firing folks or if they're doing layoffs, you are a crucial employee that they can't let go.
That is a good way of avoiding or at least reducing your risk. You can't completely avoid your risk. Things happen in the economy. No matter how good you are at work, sometimes you can get fired, you can get laid off. So always keep that in mind. But obviously, we all wanna reduce that as much as possible.
Now that risk is there. You're not gonna be able to completely get it. So to some degree, you are going to retain some of that financial risk. And if you're taking that financial risk on, as we've talked about in the other videos, one of the best ways to protect yourself is by saving money.
And I would say a combination: saving money and living below your means or having a very quick way of being able to live below your means if by chance you were to lose your income. Because if you do that, you have more time. You could live off of your savings, especially if you don't spend a lot to live, and you have time to transition to something else.
Now you can also transfer the risk to others and that's usually through some form of insurance. There is government unemployment benefits, but oftentimes that's not going to be enough to cover your expenses. And there are other types of unemployment insurance that you might be able to get that's a little bit less common for people to get unemployment insurance above and beyond that.
So most folks are usually, when it comes to loss of income, let's avoid it or minimize the chances of that happening, but then also create a nest egg. There's other forms of risk that we've talked about like liability. What happens if someone sues you because you know there's a car accident and you're at fault, or at least the judge decides that you're at fault and then you owe them a lot of money in a lawsuit?
Well, once again, the best thing to do is to avoid or reduce. Now you can't avoid that risk completely unless you're willing to just not travel or not drive or anything like that. But you can reduce it by driving safely, conscientiously, not texting while you're in the car so that you're very unlikely to be at fault if there's any type of accident.
You are a defensive driver. That's always should be the first line of attack. But then on top of that, if you could retain some of that risk, obviously, and the best way to manage that is save money, et cetera, so that if something were happen, it's not gonna be the end of the world for you financially.
And what many folks do for that type of risk, and sometimes by law, in fact, in many states you have to have liability insurance. And so then you are paying an insurance company to transfer some or a lot of that risk of liability, it's usually capped to some amount, to an insurance company.
And I recommend that as well, especially for things like liability. So once again, just always have that in front. Okay, what are my risks? Where can I completely avoid them? Usually you can't completely avoid them, but you can at least minimize them a little bit or reduce them.
And then above and beyond that, since those risks are hopefully just going to be reduced, but they're still there, how much do you take it on yourself? And to manage that, you probably need to have some savings or how much do you transfer to others? And that's probably paying someone to ensure that, "Hey, if that thing happened that insurance company's got my back to a certain degree."
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