Risk Management
What is Risk management?Risk management is taking steps to control the effect of potential risks in a comprehensive financial plan.In financial terms dealing with risks with a formal plan is controlling risk and what a good financial planner does for you. Good risk management first determines what risks there are and then proposes management solutions. First step is to identify what risks there are: Some include: Inflation, death, disability, illness, job loss, taxation, market volatility There are four basic risk management techniques used to deal with risk.
Reduction of Risk Wear your seat belt while driving and you reduce the risk of death or serious injury in a crash. (mitigate the risk) Transference of Risk. The death of the bread winner is extremely remote, but the consequences to the family could be devastating. Buying life insurance transfers risk of loss of income to the insurance company. The life insurance will give the survivors enough capital to invest to recreate the lost income of a deceased bread winner. Retention of Risk. This is the knowledge the risk exists and accepting it. Like carrying a small amount of cash on your person. You could lose the money! but it is a risk we accept. All four techniques areforms of risk management Inflation Risk (the hidden tax) Lost buying powerThose with low risk tolerance mistakenly believe GICs are a safe haven for their money. They wind up paying the highest possible levels of tax for very low returns. Factor in inflation and the return on GICs is negative each year. GICs should be used only for very short term savings.Example$100,000 deposited in GICs in 1984 and rolled over each year was worth approximately$121,000 by the year 2000. Compare that to house prices in 1984 at about $65,000. Same house price in 2000 about $220,000.It has been said those who buy GICs would be better served owning precious metals, gold, silver, platinum. Precious metals are a hedge against inflation, but only a hedge there is no gain with precious metals ExampleHouse price in 1965---$20,000 you would have needed 565 1 oz bars of gold ($35.40 per troy oz) to buy that house.Same house 2008 price $515,000 you need 565 1 oz bars of gold ($911.42 per troy oz) to buy that house. Notice it is the same amount of gold, but there was no gain. A A long term investment must beat inflation or you are wasting your money, your time, and your effort. Look at equity investments:$10,000 invested in Templeton Growth fund** in 1954 (the beginning) is worth over $6,000,000 today - average rate of return was 12.6%As you can see equity investing eliminates inflation risk completely.**this is not a recommendation of Templeton growth fund. It is an illustration of what long term equity investing can achieve using a real world example.
Death, disability, illnessWhen it comes to possible Death, Disability, or a Major Illness. We can use the transference method to reduce the risk by buying Life, Disability and critical illness insurance.This transfers the financial risk to the Insurance company. Should any of these misfortunes befall us. Job lossWith job loss we would use risk retention, by developing an emergency fund to cover your financial requirements for the short term until you found a new job.Another technique is to consider developing a second skill set that could be implemented if the job loss was to become permanent. Example: You have worked at the auto plant for 15 years, only to find out the plant is closing and moving to China. Fortunately you have been studying marketing at the local community college and are now ready to reenter the work force in an entirely different capacity. “Security is in the person not the job” Taxation RiskIs risk the strategies you implement now, can have adverse tax effects either now or worse in retirement when you are primarily on a fixed income. The technique to deal with this risk is avoidance. Take the steps now, while working with your financial planner to avoid the risk of inadvertent and undue taxation.Example insured retirement strategy RRSP meltdown are strategies that eliminate taxation. Market VolatilityThe market goes up the market goes down. When’s the best time to invest?Warren Buffet would tell you; “When you have the money” - meaning don’t worry about the market, but human beings are emotionally attached to their money. Some do worry about market volatility, but would like to be properly invested at a comfortable level. Segregated funds in a balance diversified portfolio can provide that level of comfort. The Insurance guarantees take the worry out of market volatility. Example: An 85 year old has $3,000,000 sitting in savings vehicle at the bank. She doesn’t need the money, but would like to see it grow and make sure it is available to her heirs upon her passing. She buys Segregated Funds and invests in equities. remember the Segregated Funds come with a 100% death benefit guarantee meaning even in a severe market decline the family will receive full market value or guaranteed death benefit at the time of the client’s passing. Which ever is the greater amount. The most dangerous risk of all ....The biggest-risk-Canadians-face is running out of money in retirement. That risk is be compounded by being invested in savings products (GICs) and using the wrong strategy (RRSPs)Risk Management is a balanced diversified portfolio designed to beat inflation--only equities can do that. Sadly statistics show most people will live a reduced lifestyle in retirement (approximately 90%) The odds are against you--unless you take steps now. Meet with a financial planner today and discover what you need to know to avoid that. Return from Risk management to What is a Financial Plan
Terry Johnston J C Mitchell Financial Services Inc. Phone: 866-721-7781 ext. 232 This is a quick thumbnail sketch of over all risk management. Managing financial risk is handled with different products and strategies. The information presented here is not investment advice and should not be taken as such. It is always in your best interest to speak with a financial professional, before considering any strategy or buying any product. |
