The words ‘risk management’ probably conjures up images of hedge fund managers, investors, and seasoned financial professionals. The truth, however, is that like most financial terminology, it applies to everyone. In fact, risk management is even more important for everyday individuals who are trying to make smart decisions with the money that they have – no matter how large or small the sum.
Whether trying to branch into the financial sphere or generate passive income, not calculating the risk involved in personal finance can have disastrous consequences. Risk is ultimately about sensing the potential loss that could happen, which can vary from a trivial loss to the major financial hardship that negatively impacts your livelihood.
The biggest hurdle for many people though, is understanding the concept of financial risk and knowing how much volatility they’re comfortable with. Judging the balance between the input and the likelihood of a pay-off doesn’t come naturally to many of us, especially if we have limited savings or a restricted budget. There’s also the realization that using financial advisors doesn’t remove the need for risk management – some advisors may not be completely objective or may simply not know better.
So, moving forward, it’s essential to conduct some sort of risk management in your personal finances. But what does that look like? Here are some actionable steps to be risk-aware and averse with your money:
What is personal financial risk management?
Every action we take in life carries a level of risk – you could walk up the stairs and trip or you could go outside and be struck by lightning. The intensity and repercussions of these risks varies massively, and for that reason, we can make predictions about whether the action is worthwhile and how often we want to repeat it.
We can’t eliminate the risk entirely, but we can manage it.
The same is true for your finances. Personal financial risk management is about preparing and protecting yourself in the event of an unexpected outcome. Any good financial plan is split into two parts: ‘wealth creation’ and ‘wealth preservation’. Personal financial risk management focuses on the second part, on the risks that can hinder or help you maintain your money on a long-term basis.
It’s important to note that taking risks with your money isn’t a bad thing – but doing so without being sufficiently informed can be reckless. Personal financial risk management empowers you to take more controlled risks, to lessen the chances of a harmful decision, and to maximize your financial resiliency.
Save an emergency fund
60 percent of Americans don’t have enough savings to cover a sudden $1,000 expense, meaning more than half of the population have a small pool of money that they are reliant on and have to protect with greater caution. As a result, their financial decisions are higher risk because their income is not disposable – basically, any losses would have a stronger negative impact on their lives.
Building an emergency fund is a prime way to offer a cushion for your finances and have greater flexibility when it comes to risk. If you aren’t heavily dependent on a limited amount, you have more freedom to explore long-term investments.
An emergency fund should be part of your financial routine, where you set aside a certain amount each week or month. This fund should be untouchable and preferably in a high-yield savings account, where it will serve as a fallback if you encounter any risks elsewhere in your daily spending. Not to mention, having an emergency fund will enable you to take more calculated risks with potentially high returns because you can determine whether the possible loss could be shouldered by part of your emergency fund.
Diversify your income sources
Spreading risk is key in personal finance risk management. If your generated income comes from one place, there’s a higher risk that if that channel is cut (e.g. you lose your job) your finances will suffer greatly. By having multiple income streams, you aren’t solely reliant on one form of income and can enjoy peace of mind that your livelihood won’t be determined by one source succeeding or stalling.
Diversifying your income can take money forms – you could turn a hobby into a side hustle, pick up a part-time job, sell items online or participate in paid marketing surveys. Opt for something that you can see yourself sticking with for a while, so that you can earn a good amount of money alongside your main income. You also find that your new profession opens doors to other opportunities where you can earn even more money, for example being offered freelance work or achieving a paid influencer status.
A word of warning though – don’t be tempted to branch into the cryptocurrency space to diversify your income. Cryptocurrencies are assets that have no intrinsic value, have no barrier to multiplication, and don’t have a firm use case as money. These digital currencies are of speculative interest only and many people – particularly unqualified investors – have experienced severe losses in the space.
Build your financial education
Your personal finances are just that – personal, so you have an individual responsibility to understand and stay up to date about changing finance dynamics. Of course, as a beginner, this can be daunting, but luckily there are plenty of readily-available (and free) resources to support you on your journey.
Investopedia has in-depth articles guiding readers through the jargon and concepts of the financial realm, it also has tutorials and plenty of real-world examples of personal finance risk management. Elsewhere, MyMoney.gov is run by 22 federal entities and has a host of free and expert information around financial data and planning. It also has current economic and financial statistics, so you can stay on top of markets and the wider economy.
Alternatively, there’s a broad range of books to help you understand money or you could schedule a consultation with a number of financial advisors (don’t put all your eggs in one basket) to sample people’s recommendations for you. The thing to bear in mind here is that you don’t have to act on all the things you learn, but that you use all that knowledge to establish an in-depth understanding of the risks you face and how to shield yourself against them.
Use credit cautiously & be wary of schemes
Credit should never be abused, as it can easily land you in a situation where you misjudge the risk and fall into serious debt. That said, with the right financial education and research, credit cards can be a way to leverage the spending you already do. If you’re eligible, sign up for a cash-back or rewards credit card so that you can reap extra benefits on top of your standard payments; for example, the Capital One credit card offers unlimited 1.5 percent cash back on every purchase, every day. Only consider this option if you’re in a position to meet the required monthly repayments.
At the same time, be wary of other schemes that seem too good to be true – they usually are. Many companies, investors, and programs will claim that they can help you earn money quickly but that’s never the case and often comes at a heavy price. Having good risk management means being able to recognize when a proposal isn’t totally transparent, and when you’re only being told what you want to hear, rather than the actual reality.
Doing your due diligence will always be necessary when assessing risk. Remember to look over the fine print for anything you commit to, and if you’re unsure, don’t be afraid to ask a professional to review it too. Additionally, you can read online reviews or browse finance forums and communities for tips about trusted investments.
Life is full of uncertainties, and it’s inevitable that you will come across financial risks at some point. While you can’t control those encounters, you can anticipate and protect yourself when they arrive. By saving, diversifying, and staying informed and cautious, you can better manage your finances with a risk-detection lens and feel assured that your finances are in your hands – whatever the acting external factors.