Why Risk Management Is A Key Consideration For Any Financial Plan

Risk management is a crucial aspect of financial planning to ensure that you can achieve your financial goals whilst minimising any potential setbacks. Some of the ones we have identified with our clients are detailed below:

Risk management consideration for a financial plan

1. Risk assessment and identification

Begin by identifying the various risks that could impact your financial goals. These risks could include market volatility, inflation, longevity risk (outliving your savings), health-related expenses, job loss, and more.

2. Goal clarity

It’s always important to clearly define your financial goals, whether they are short-term, medium-term, or over the long-term. This helps you to assess the level of risk tolerance you are able to or are comfortable taking for each of your set financial goals.

3. Risk tolerance

Understand your own risk tolerance and comfort level with taking risks. This involves considering your age, financial situation, investment knowledge, and emotional reaction to any market fluctuations, whether that be up or down. In other words, how would you feel and how would it affect your standard of living, if your capital reduced in value.

4. Diversification

The rationale behind diversification is rooted in the idea that different assets have different levels of correlation with each other. Diversifying your investments by spreading them across a variety of different asset classes (for example equities or stocks and shares, bonds, property, and cash, etc.). can help to reduce risk. The primary goal of diversification is to minimise the impact of the poor performance of any single asset or a small group of assets on an overall portfolio. By investing in a wide range of assets that react differently to various economic conditions, an investor can potentially achieve a more stable and balanced portfolio.

5. Asset allocation

Asset allocation refers to the strategy of distributing an investment portfolio across different types of assets, in order to achieve a desired balance between risk and return. It’s a fundamental concept in investment management and is used to help you achieve your financial goals whilst managing the level of risk you are comfortable taking.

6. Emergency fund

Having an emergency fund or an amount left in cash is crucial for financial stability and peace of mind. It serves as a safety net that can help you navigate unexpected expenses and life’s uncertainties or in the case of unexpected events like job loss/ income reduction or unforeseen medical emergencies, without derailing your overall financial goals. It’s an essential component of a well-rounded and healthy financial plan. The general rule of thumb is to have three to six months’ worth of living expenses saved up in an easily accessible account, like a savings account or a money market account. The exact amount you need might vary based on factors like your job stability, family size, and comfort level.

7. Insurance coverage

Adequate insurance coverage is essential. This includes health insurance, life insurance, disability insurance, and long-term care insurance, depending on your needs and life stage.

8. Estate planning

Plan for the orderly distribution of your assets after your passing. This can involve creating a Will, setting up trusts, and designating beneficiaries on accounts.

9. Regular review

Regularly review and update your financial plan to ensure it aligns with your changing life circumstances, financial goals, and risk tolerance.

10. Tax efficiency

Consider the tax implications of your investments and financial decisions. Tax-efficient strategies can help you retain more of your earnings.

11. Market conditions

Stay informed about current market conditions and economic trends. Whilst you can’t control these factors, being aware can help you make more informed decisions.

12. Behavioural bias

Be aware of behavioural biases that can affect your decision-making, such as the fear of missing out (FOMO) or the fear of loss. These biases can lead to impulsive and irrational decisions.

13. Scenario analysis

Run scenario analyses to understand how different market conditions or life events could impact your financial plan. This can help you prepare for a range of possibilities.

14. Contingency plans

Develop contingency plans for potential disruptions to your financial plan. For example, consider what you would do if your income decreased significantly or if you needed to cover unexpected expenses.

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Remember that risk is an inherent part of investing and financial planning. The goal is not to eliminate risk entirely but to manage it in a way that aligns with your goals and comfort level.

Nelsons have a team of qualified Independent Financial Advisers who can help you navigate these and other complex financial decisions and provide you with a personalised financial Plan.