Risk Management: Its Significance In Financial Planning And How You Can Do It 

All investors face some inevitable risks even if the degree of the risk varies. However, the risks prevalent in the market can be navigated through risk management. Every investor has a different risk-taking capacity and thus has to formulate different strategies for risk management.

On one hand, an investor with an aggressive investment style is likely to take more risks, on the other hand, a more conservative investor might have a smaller risk appetite. Often the level of risk an investor is comfortable with also depends on the age of the investor. Typically, younger investors have a relatively bigger risk appetite than that of a person in their 40s or 50s as they are closer to retirement and may not be able to absorb the. However, no matter what the degree of risk is, it is important for every investor to carry out risk management in order to take a calculated risk and safeguard themselves from any potential losses.

Significance of Risk Management

Risk management is crucial for financial success, as modern organisations face increasingly complex risks due to globalisation, technological advancements and climate change. Unforeseen events such as COVID-19 can affect the market negatively and create market volatility and instability in the economy. Investors should assess the risks associated with each investment separately and also see the degree of risk their entire portfolio has cumulatively.

Once an investor understands the degree of risk their portfolio is exposed to, they can either increase their exposure to risk for potentially higher returns or decrease the exposure for stable and relatively lower returns.

Tools For Risk Management

Asset Allocation

Asset allocation involves finding the right mix of asset classes to reach the best possible outcome. The asset classes such as stocks, bonds, cash, real estate, commodities etc can be invested in to diversify an investor’s portfolio.

Diversification helps in reducing the overall portfolio risk, as different asset classes perform differently under different market conditions.  These asset classes need to be chosen in such a way that the profit from one asset class makes up for the losses from another one.

Monitoring and Rebalancing

The risk needs to be monitored in a periodic manner to rebalance your assets and come up with a game plan. Many traders closely monitor the market to see when to let go of an asset that can cause significant losses and when to acquire one which can potentially offer them gains. Ideally, investors should monitor their portfolio on a periodic basis rather than every day. Experts suggest that risk monitoring and rebalancing should be done at predetermined intervals so as not to make impulsive decisions.

Liquidity

Illiquid investments, like real estate and private equity, cannot be easily sold for cash without making a loss. Maintaining a portion of liquid assets in your portfolio can help you use your assets to meet short-term needs without having to sell other investments at unfavourable times. This helps in creating a portfolio that can be easily used in a financial crunch.