Types Of Risks In Personal Finance And How You Can Manage Them
In life, there is no such thing as “risk free”. Everything has a risk, and that goes doubly so for anything related to personal finances and money.
When we talk about financial risk, it is a form of risk that arises from an event and has a negative impact on an individual’s financial condition.
The losses caused by financial risks can be very diverse. These can include loss of assets, experiencing large amounts of financial losses, disrupted cash flow, and more.
While it may seem difficult at first, there are a number of things that you can do to mitigate these risks. However, in order to do so, we must first understand what the risks are in the first place.
Types of financial risks
The two main ones you should know are systemic and non-systemic risks.
- Systemic risk
Usually, you can’t predict or avoid these type of risks due to several factors as they are outside your individual control. Examples of these include things such as a pandemic, increased interest rates, increased market volatility, and so on.
- Non-systemic risk
Is a financial risk that befalls a person, organisation, or group due to an event. For example, if you are being confined to bed due to sickness/illness, or even death.
Personal financial risk
This kind of risk can happen to anyone and at any time. It is usually divided into four categories. These are:
- Income risk
These are the risks that have the potential to affect an individual’s income. It can be anything ranging from injury that prevents you from working, getting laid off, having your wages reduced, and more.
- Expenditure risk
This kind of risk arises when you pay out money to meet your needs, but the expenditure threatens to be greater than income earned. It can also include situations where an emergency forces you to spend a large sum of money, such as an accident requiring expensive medical treatment or a home renovation project due to certain damages incurred.
- Investment risk
Investment risk, otherwise known as asset risk, is the risk you face when investments or assets you own face several obstacles. These include loss of investment assets, theft or damage to assets you own, asset values depreciating in value, insufficient savings to continue investing, and more.
- Debt risk
Also known as credit risk, is the kind of risk associated with not paying your debts, be it intentional or otherwise. It can also include things like financial penalties, being trapped in debt with high-interest rates, and being a guarantor for someone else, and more.
Time based risk
When viewed through the lens of time, this sort of risk can be divided into two: short-term and long-term risk.
- Short-term risk
These kinds of risks usually occur suddenly and unexpectedly, and take place over a relatively short period of time. Your car battery dying out suddenly would be a short-term risk as you will have to spend some money and a relatively short amount of time getting it fixed.
- Long-term risk
As its name suggests, long-term risk has the potential to affect your finances over a long-period of time. This kind of risk will generally have a more serious effect on your finances over time. The loss of your main source of income serves as an example of such a risk as it has the potential to majorly affect your future financial prospects.
How to manage financial risks
This is not an easy question to answer as we cannot truly predict how financial risks will actually turn out. Sometimes financial risks will lead to devastating results, while other times, it can be a false alarm. However, there are definitely ways to mitigate financial risks, and in some cases, avoid them to an extent with the right amount of preparation. Here are a few tips you can apply.
Have multiple sources of income
Many people will only have one full-time job as their sole source of income. However, having another source of income not only increases your overall monetary gain, but also serves as a buffer to help minimise financial risks.
The extra cash earned from doing a side hustle or some freelance work while also working at your full-time job will give you some leeway in the event that something happens to you or your job.
Creating a financial plan is key to ensuring a healthy and stress-free future. To create one, make sure you summarise where your finances are now and where you want it to be in the future.
From there you can decide on how you can go about achieving said financial goal. It also makes it much easier to manage your income and expenses from month-to-month.
Insurance policies can save you a massive headache down the line. While there are certainly some insurance policies you can do without, others are almost essential in helping you to save your financial condition.
For example, life insurance is crucial in the event that a family’s sole breadwinner meets with a life threatening accident. Health insurance is another good example of essential insurance. As you get older, medical treatments become more common, and occasionally, more expensive. Health insurance can help to mitigate these costs without biting into your retirement fund too much.
It goes without saying that living on a budget is key to maintaining your financial wellbeing. Once you have laid down the foundations of your financial plan, you can start budgeting in order to achieve your goals. This will allow you to determine what are the essentials you need to pay for, and what can be cut out of your budget.
A properly planned budget also allows you to organise an emergency fund, which is something everyone should have. This fund is set aside for any unexpected emergencies and will typically consist of approximately 6 months worth of your earnings.
Steer clear of debt
Taking out loans is a part of modern day life. Even credit cards are essentially another form of loans. What is important is that you pay off these debts in full and do not default on them. If you do not pay off your debts in time, you may find that it will spiral out of control.
Properly research how much you can afford to pay back each month and decide what kind of debt you want to take on based on that.