Risk management is very important in Financial Planning

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Risk management should ideally be the focus point of any investors' financial plan. However, unfortunately there are number of investors who do not focus on this very important aspect of their investment process.

 

Usually, investors have to manage two types of risks. One risk is to the investment that they make.

 

Second is the risk of any financial distress to the family member in case of an unfortunate event of a death or a disability.

 

As far as the investment risks are concerned, there are broadly four types of risks that an investor need to manage. Firstly, there is a performance risk. Every investor portfolio has a mix of securities and they tend to behave differently over different time periods. This obviously over a period of time have an impact on the portfolio return. So to minimize the impact of these non-performing securities on the portfolio, it is very important for every investor to have a diversified portfolio. So diversification is the key here.

 

The second risk is the volatility risk. There are asset classes like equity and to an extent even gold, which have the potential to do very well over the longer period. However, for an investor to benefit from the long-term potential of these asset classes they have to manage the risk of volatility in the medium-term and short-term, which can be done by a systematic investment. So disciplined investor can benefit over the long-term.

 

Third risk is the risk of inflation. This perhaps is the biggest risk for any long-term investor. Therefore, the asset allocation has to be such that it should be able to beat inflation over a period of time. It is equally important to invest in those instruments, which have the potential to provide tax efficient return. So that investors can earn positive rate of return on consistent basis. This is where I think options like mutual fund score over others.

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