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Lecture Personal financial planning – Chapter 10: Risk management

Lecture Personal financial planning – Chapter 10: Risk management. The goals of this chapter are: Evaluate risk management as an overall household approach, distinguish the types of risk that people are exposed to, demonstrate how risk modification leads to improved financial management, . | Lecture Personal financial planning Chapter 10 Risk management Chapter 10 Risk Management 1 Chapter Goals Evaluate risk management as an overall household approach. Distinguish the types of risk that people are exposed to. Demonstrate how risk modification leads to improved financial management. Analyze the central role insurance plays in reducing risk. Establish the common types of insurance available. Compare whole life and term insurance. 2 Risk Management Theory Risk management in theory can be viewed as the study of methods for controlling portfolio risk. The goal is to have the highest quality of life possible given your tolerance for risk. There is no grouping of assets or other techniques that can fully eliminate risk in your portfolio primarily due to the lack of a full hedge for human assets. Products with negative correlation are costly. Further human assets such as unemployment and health insurance are available but do not control all risks. Further we cannot hedge away overall market risk. 3 Risk Management Theory cont. Risk management techniques are methods of modifying a household s portfolio risk. An overall portfolio risk is established and current portfolio risk is compared preference for risk. The most efficient risk management technique is then selected to bring the portfolio in line with tolerance for risk. In revising the portfolio one establishes a risk return strategy that attempts to optimize portfolio income and brings about the highest standard of living possible. This approach is a part of the foundation of Total Portfolio Management. 4 Risk Management in Practical Terms In practice we are only concerned with outcomes that are below expectations as these are the outcomes that produce losses. Risk management in practical terms is defined as the process by which we identify risks and control them so that we are able to achieve individual goals. When engaged in financial planning you must first identify risks knowing that losses in any .