Take calculated financial risks but not more than you can afford to lose
Take calculated financial risks but not more than you can afford to lose.
Insurance works on the principle of 'spreading the risk and sharing the loss'. Calculated risk is often essential to a profitable financial plan, but sometimes it can also mess up the sums. Here is how poor risk management can spoil an excellent plan: a 40-year-old man drafts a retirement plan according to which his investments would mature when he retires at 60 and he nominates his wife as the beneficiary. The plan is inflation-proof and yields sufficient tax benefits. Unfortunately, the man dies at 42 leaving his family with either no assets or assets that will mature before 18 years.
Financial planning isn't complete without proper risk management to ensure that any loss suffered due to an unfavourable outcome of an event is made up for. There are two categories of risk-speculative and pure. Speculative or investment risk has three possible outcomes-gain, loss or status quo. The value of an investment in gold, for instance, can increase, decrease or remain the same. In this scenario, no insurer will provide cover to make good the losses. Pure risk can have just two outcomes-status quo and loss. Driving, for example, can either lead to an accident or not. To cover losses from pure risk, different insurance policies are available.
Pure risk can be personal risk (death, disability, illness, accident), property risk (fire, theft, accident), liability risk (if a maid gets an electric shock in your house, you are liable to pay her or fund her treatment). All of these are covered by insurers. But before you head out to buy insurance, learn these simple rules of risk management.
Don't risk more than you can afford to lose. If the impact of your risk is going to be unbearable, it is prudent to insure. The death of an earning member can be disastrous for the financial health of a family, so it's wise to buy life insurance for that member.
Consider the odds. If the risk is high, insurance may not be your best option. Its more prudent for a grain merchant to shift his warehouse from a flood prone area than insure it.
Do not risk too much for too little. Most accident policies don't cost much. But the cost of dealing with an accident is often high, more so if the victim is the main earning member of a family. In this case, it is prudent to buy an accident cover.
There are two techniques to manage risk: risk control and risk financing. Risk control involves avoidance (quitting smoking to reduce the risk of diseases) and reduction (a tobacco chewing person would do well to smoke filtered cigarettes).
If a risk can't be controlled, it's important to have a strategy to make good the financial loss that may result from it. This is called risk financing. It involves risk retention (a company may not insure its employees for minor sicknesses such as cough and cold and instead bear the cost of treatment itself) and risk transfer (the same firm should take insurance cover for illnesses that cost a lot to treat).
It's this transfer of the risk of financial loss to an outside agency that is the basic principle of insurance.