Risk Management 101

Updated: September 4, 2021

How do you manage risks, especially in investing? To answer this question, we must first define what risk is, then learn how risks are typically handled in real life situations.

And this is our simple lesson for today, Risk Management 101.

What is risk?

It is the potential of loss, which is an undesirable outcome, resulting from a given action, activity and/or inaction.

That definition comes from the Wikipedia entry of Risk and if you think about it, risk is basically “something bad” that we don’t want to happen.

So examples include failing in a test, getting sick, losing a basketball game, hurting yourself in a car accident or losing money in an investment.

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Four Basic Ways To Manage Risk

Risk Avoidance
The first option is to eliminate the risk. For example, if you don’t want to fail in a test, then don’t take the test at all. It’s pretty straightforward.

And when it comes to investing, if you don’t want to lose money, then don’t invest at all.

Risk Reduction
The second option is to lessen the chances that the undesirable outcome will happen. If you don’t want to get sick, then you can eat a balanced diet and exercise regularly. You won’t avoid getting sick, but the chances are greatly reduced.

In investing, you have a lower chance of losing money if you invest in low-risk investment products such as money-market funds or treasury bills.

Risk Sharing
The third option is to transfer some of the risk to another party. For example, rather than playing 1-on-1 basketball, you can opt to play 3-on-3. If you lose the game, then the “agony of defeat” is felt not just by you, but shared with your teammates as well.

When investing in a business, you can opt to get partners. If the venture fails, then you won’t lose as much money as compared to putting up the business alone.

Risk Retention
The last option is to accept the risk and prepare for it in case it happens. Yes, you don’t want to get hurt in a car accident, but you still went ahead and used the car to go to the place you want to be.

You probably just said to yourself, “If it will happen, it will happen.

When putting money in a high-risk investment, you should to some degree, be okay with losing money in the end. You should be able to accept that fact and prepare an action plan in case it happens.

Risk Management Planning

Now that you know the four basic ways to manage risk, you can now plan for it using a combination of strategies.

Let’s say you want to invest in the stock market, then you can manage the risk of losing money in it by doing the following:

  • Avoidance: Putting off investing until you learn and fully understand how the stock market works.
  • Reduction: Lessen the risk of losing money by following the advise of stock market experts.
  • Sharing: Share possible losses with other investors by putting your money in an equity fund instead.
  • Retention: Investing only money you can afford to lose.

There are many other ways you can manage risks when it comes to investing in the stock market. One example would be to do strategies such as Cost Averaging.

The Financial Impact of Dying

What will happen to your family when you die? Will they experience financial difficulties? Where will they get the money for their daily expenses?

How do you manage this type of risk?

  • Avoidance: Build massive wealth while you’re still alive so that your family will have lots of money when you die.
  • Reduction: Create multiple sources of income for your family so that cashflow won’t stop when you pass away.
  • Sharing: Buy life insurance to effectively share or “transfer” the financial burden of your death to the insurance company.
  • Retention: Accept the fact that life in unpredictable and live everyday as if it’s your last.

This concludes our short lesson on Risk Management. I hope you learned something from it. Do leave a comment below if you have any questions, and please don’t forget to subscribe to our newsletter below if you haven’t yet done so. Thanks!

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5 comments

  1. Nice posted, cost averaging works for me in terms of retirement fund. Thanks again Fits more power to your blog.

  2. Agree with Mike. Though I probably wouldn’t pass bootcamp, much less be part of special forces, I learned something like that in IT.

    When project planning, risks to the project are evaluated the same as you outlined. Except that probability and severity are also estimated.

    Those unlikely to occur or are very easy to deal with may not have risk mitigation actions. for the others, the action plans (mitigation, contingency) or parts of it are built into the project estimates to anticipate according to how probable they are to happen and to how severe the outcome would be.

    Awesome article, by the way! I didn’t think of connecting this with personal finance. But it’s actually very helpful in financial planning.

  3. Very good article. I really enjoyed reading your blog. Very inspiring. Keep up the good work Sir :-).

  4. Controlling market risk is a “hot topic” in my home. I have written in the past how long for the day that there will be more ETFs listed on the PSE and eventually the trading of option contracts. Many folks fear option because of what they think they know about the subject. It was the mis-use of options for wild speculation that gave the product a bad reputation. In truth, options were created to help mitigate and spread off your risk. Reading a few good option books will help educate those interested.

    ETFs eliminate single stock risk. I like the fact that most have very low expense ratios and may be traded any time during market hours just like a stock. One stock in the S&P 500 index or the SPY ETF taking a hit from bad earnings will NOT tank the entire index or the ETF based on it. Slower way to earn but much safer especially for beginners. Now, imagine with me, if you will, that FMETF listed on the PSE will offer option trading in the future. There are so many combinations you can use to protect a nice profit you have built up over several years holding your position. You could have also earned some regular income buy selling OTM (Out of The Money) options against your long position on the ride up.

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