Friday, May 11, 2012

What is Risk?

5:49 PM

Risk Defined
Risk is the potential that a chosen action or activity will lead to a loss (an undesirable outcome).

[...] Almost any human endeavor carries some risk, but some are much more risky than others."

-- Wikipedia
When it comes to retirement, risk is the possibility of a loss or other adverse event that has the potential to interfere with your financial security.

What is risk management?

Risk management is a methodology that looks at each potential risk and ensures that you identify and understand the risks to which you are exposed. This information helps creating an effective plan to prevent or reduce the impact of losses.

Risk management provides a clear and structured approach to identifying and dealing with risk.

Why manage risk?

As we are nearing retirement, many things can go wrong and derail our retirement plans. For example, negative equity returns, loss of employment or health issues can impact our planned standard of living or time of retirement. At the onset of retirement, poor investment performance combined with investment withdrawals can rapidly deplete assets. All these possibilities are risks that need to be managed to ensure we enjoy a worry-free retirement.

What’s the process?

Elements of a risk management methodology consist of these steps:

  1. Identify, characterize, and assess threats,
  2. Assess the vulnerability to specific threats,
  3. Determine the risk (i.e. the expected consequences of specific types of attacks on specific assets),
  4. Identify ways to reduce those risks, and
  5. Prioritize risk reduction measures based on a strategy.

So we need to identify and assess each risk, determine the potential outcome of each adverse event, find approaches to remove each risk and decide on cost-benefit trade-offs in order to arrive at a workable solution.

Techniques to manage risk fall into one or more of these four major categories:

  • Avoidance (eliminate)
  • Reduction (mitigate or control)
  • Transfer (outsource or insure)
  • Retention (accept and budget)

Retirement requires careful planning. Having a clear understanding of all risks allows you to prioritize them and have a contingency plan should they occur.

In the next few posts, we will explore each of the main pre-retirement and post-retirement risks.


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