Is managing risk an important part of financial planning

Unfortunately, risk management is something that many people ignore when making decisions about their money.

Not managing risk can often result in painful situations; it is possible for one to lose wealth at a faster rate than they earn it.

In this article, we’ll go through some of the most common risks Singaporeans have to manage when making financial plans.

Unexpected, expensive situations

What would you do if you suddenly had to fork out $50,000 in cash today? This situation sounds shocking and unlikely, but it’s more common than you think.

Getting hospitalised, getting into a car accident, and having your home destroyed by fire are all examples of such scenarios. Singapore might be one of the safest places in the world to live, but Singaporeans still fall prey to accidents and illnesses.

The good news is that you don’t need to store large amounts of money to guard against calamity. Most people do the savvy thing – have insurance coverage and live a life without constantly worrying about forking out huge sum of money for unforeseen situations.

There’s insurance for a wide range of these scenarios.

Hospital bills? Check.

Have a tree fallen on you? Check.

Getting an infectious disease? Check, check, check.

Investment Risk

When the word ‘risk’ is mentioned in financial planning, many people think about this.

Indeed, people losing fortunes on the financial markets regularly make the headlines globally. That said, there are also plenty of people who invest their money without catastrophic consequences – and actually manage to grow their money!

The volatility and unpredictability of the financial market suggest that proper portfolio diversification is key to sustainable long-term investment returns.

This is why you should take the additional step to understanding your own risk appetite and what exactly you are investing in.

Sounds a little overwhelming? Don’t fret! There are a lot of financial tools out there that can help you get along the way. But beyond doing it all yourself, there are Financial Representatives that can help you navigate through it all.

Inflation Risk

If you don’t invest, you’re not taking any risk…right?

Wrong.

Inflation is a phenomenon that causes the value of your money to diminish over time. What this means is that your buying power gets reduced; the cost of goods can rise at a rate that you might be unable to afford things.

In Singapore, one clear example of this is housing. Using the MAS inflation calculator, we can see that a flat which cost $350,000 in the year 2001 would have cost about $464,163 by the year 2021.

Inflation rate risks become more drastic, as the amount involves increases.

For example, if your total savings are just $1,000, then three per cent inflation means you’re losing $30 in purchasing power per year – no big deal. But if you’ve saved up $500,000 for retirement, three per cent inflation can mean a loss of $15,000 in purchasing power over the year.

Financial planning needs to take into account the inflation rate, as well as the risk of the inflation rate rising faster than expected.

A loss of income

Finally, this is the type of risk that’s rarely talked about but is absolutely devastating when it happens. This could be due to retrenchment, being medically unable to work, or even the death of the family’s main breadwinner.

There are some types of insurance that will mitigate the impact of the loss of income. Here are some classic examples:

Accident, Critical illness insurance and Life Insurance give the policyholder or their loved ones a lump sum payout that can be used to receive financial support.

Disability income insurance gives the policyholders some income if they are unable to work; this policy ends when the disability goes away.

In all the above examples, the difficulty is determining how much of a pay-out you’ll need, and whether the premiums are affordable for the coverage given. .

What does this mean to your financial planning?

This means that risk isn’t just important to financial planning; it is very much the core concept of financial planning.

Saving, investing, and insuring yourself are not just ways to get rich and go on long holidays (although they could empower such aspirations).

Rather, the main aim is to shield your quality of life and provide for your family, from the various risks we all face.

Risk also affects financial planning on an emotional level. Some people are more averse to taking risks, whereas others are eager to go for high-stakes, high-reward investments.

Many people engage Financial Representatives to provide professional and rational advice; this prevents them from making emotional financial decisions that they might regret later.

Indeed, in more ways than one, how well you manage your risk, will determine how well you manage to keep your wealth.

Is risk management important in financial planning? Of course, it is.