Major Types of Personal Financial Risks6 min read
Financial risk refers to the possibility that a company will be unable to meet its debt repayment commitments, which could result in potential investors losing their money. The greater a company’s debt, the greater its financial risk.
Anyone considering investing will be advised about various financial dangers, such as currency risk, as well as ways to mitigate them, such as hedging. Businesses are vulnerable to financial risk, and shareholders and potential shareholders must be aware of this.
In this article, we will discuss how to risk management in personal finance, what are the risk and types of risk in personal finance, what is the investor life cycle, what kinds of risks in personal finance, and some financial risk examples
Classification of risk in insurance
Every investment entails some level of risk. We must be able to identify the type of risk we are dealing with when it comes to personal risk management. The major categories of personal financial hazards will be discussed in this article.
There are four types of risks that we may encounter. Income Risk, Expense Risk, Asset/Investment Risk, and Debit/Credit Risk are the four types of risk.
Major Types of Personal Financial Risks
You must examine the risks associated with your income, cash, and investments when planning your financial goals. Prudent investors assess their risk tolerance and make appropriate investments to ensure that their objectives are met, notwithstanding the hazards that they may face.
Let’s look at some of the most common types of risks in your financial plan and how to minimize, share, or transfer them. The following sorts of personal dangers will be examined:
Types of Personal Risks
Here are we discuss the types of risk, which are the 4 ways to manage risk & which are the types of personal finance etc.
1. Income risks
This type of risk is directly related to your ability to earn an income. Thereby resulting in the loss of income, due to the following reasons:
- Disability and therefore unable to work
- Losing of the job
- Under-employment, due to which you are unemployed
- Outliving the income produced from the assets, from the aging perspective (specifically, for retirees cases)
Methods to manage the Income Risk | Personal risk Management
There are majorly two ways of managing the income risk, such as avoiding the risks and transferring such risk. Let’s see, how?
1. Avoid the risk :
- It is highly important to avoid risk, but having numerous alternative income sources, such as spouse income, part-time blogging/freelancing, and so on, is not always achievable. In order to assist decrease the risk of unemployment and underemployment, appropriate career management for continual learning is also critical (as the case may be).
- To lessen the chances of outliving the assets that provide income, proper retirement planning, frugal i.e. inexpensive living, and annuity planning are essential.
2. Transfer of risk :
- In order to ensure that the surviving family members may keep the same lifestyle if they die, the appropriate level of life insurance coverage must be purchased.
- Disability insurance can be purchased to help with financial hardships if you become handicapped.
2. Expense Risks
Expense risks are those that may arise as a result of the following factors:
- When you spend more money than you earn, you are said to be in debt.
- When your income is insufficient to cover your needs
- When you have an emergency, you are forced to spend money.
Methods to manage the Expense Risk
In order to manage the risk, one may manage it by avoiding such risks or by transferring it. Let’s see, how?
1. Avoid the risk:
- Budgeting can be used to prevent the expense risk and to keep expenses under control. It aids in the reduction of your expenses. For a better understanding of non-relevant expenses, one can use the 50/30/20 rule, which is peculiar to India.
- Learn how to make extra money so that you can make more money than you spend.
- Create an emergency fund so that you have cash on hand in case of an emergency, i.e. a contingency. Please see our articles ‘Contingency Planning – An Overview’ and ‘Contingency Fund – How to Manage?’ on https://finplanyadnya.in/ for more information.
2. Transfer of risk:
- To protect against big calamities, one might get appropriate insurance plans such as vehicle insurance, home insurance, and umbrella insurance for expense management planning.
3. Asset/Investment Risks
- Your assets include your investments as well as other assets such as your home, automobiles, jewellery, and other personal belongings. Regrettably, they are all prone to a variety of threats, including the following:
- Not saving enough or investing wisely enough to achieve your financial objectives
- You don’t have the correct investment mix for the goal you want to achieve.
- Investing money and losing it (principal)
- Return on investment (ROI) that isn’t up to par
- Investing portfolio that is under-or un-diversified
- Your belongings are stolen or destroyed.
Methods to manage the Asset/ Investment Risk
In order to manage the asset or investment risk, one may again avoid it or transfer it. Let’s see, how?
1. Avoiding the risk:
- Make sure you have adequate money set aside for your financial goals. You’ll need to make a financial plan and evaluate it on a regular basis to achieve this.
- Learn about each asset class’s risk and return characteristics so you can select the best investment mix for your specific financial objectives.
- Learn about the features of each investment type in terms of capital preservation.
Your money is reasonably safe in your savings account, CD (certificate of deposits), money market, and treasury, for example, but the trade-off is mostly/ substantially lower rates of return, possibly lower than inflation. On the other side, the stock market, small business, and real estate all carry the risk of losing everything, but the potential rewards on investment are bigger.
- To minimize the risk of diversification, one must first comprehend the concepts of investing correlation and diversity. It aids in lowering your total investment portfolio’s general volatility and risk.
- Avoid investing in assets that will lose value over time to lower your depreciation risk. Automobiles, fancy jewellery, and gadgets are the most apparent examples. These things are certain to lose value over time 99.99 percent of the time.
- Inflation is a persistent factor that gradually reduces your purchasing power. The only way to protect oneself from inflation is to invest in assets that outperform it. Fixed Deposits, Debt Instruments, Debt Funds, precious metals, commodities, and other assets, for example, increase in value in lockstep with inflation. Stocks, mutual funds, ETFs (Exchange Traded Funds), real estate, and other investments have the potential to outperform inflation.
2. Transfer of risk :
- With the right insurance, you can protect your physical assets from theft or destruction.
- Example: Home insurance, auto insurance, business insurance, and so on. Furthermore, umbrella coverage might help you limit your personal liability.
4. Debt/ Credit Risks
Credit/Debit Risks are dangers that may arise as a result of the following factors:
- Having an excessive amount of debt
- Instead of accumulating good debt, you’re accumulating bad debt.
- Overspending on debt-related costs such as rising interest rates, finance charges, and so on.
- Credit problems
Methods to manage the Debit/ Credit Risks
In order to manage these Debit/ Credit risks, one may avoid it. Let’s see, how?
1. Avoiding the risk :
- We are all aware that having too much debt is harmful, and we should aim to avoid it as much as possible.
- Learn the difference between good and bad debt and stay away from the bad. Debt that builds an appreciating asset, such as a home loan, an education loan, or a business loan, is considered good debt. Other types of debt, such as personal loans, credit card loans, and car loans, are considered bad debt.
- If you’re currently in debt, especially bad debt, pay it down as quickly as possible to cut down on debt-related expenses. Follow the guideline that your total spending, including necessities such as housing and wants such as lifestyle, debt, and so on, should not exceed 50% + 20% of your income.
- Giving credit to others and earning a nice interest rate is common in India. This is an extremely dangerous exercise that, more often than not, results in bad credit. It is usually preferable to avoid this situation.
- A credit score is becoming a more significant criterion for obtaining a new loan, and it is critical that you maintain track of it and increase it in order to obtain easier and less expensive loans.
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