Risk - An Everyday Part of Life

Risk is an everyday fact that everyone faces. Risk can take a form of getting up the first thing in the morning and taking a shower and slipping in the shower. Risk can take a form of driving to work and taking the chance that you will not get into an accident. Risk can take a form of someone working at a construction site and the risk someone may get injured at work. Risk can also take a form of flying in an airplane and for it not to crash. In essence, in every area of someone’s life they will take a risk.

Risk is someone making a decision and for it not to result in something negative.

Since there are many forms of risk you can take, there will be different ways for someone to measure it. Now that we are talking about Finance and specifically financial management, we will address the aspect of everyday financial decisions that business leaders and families make in regards to risk.

For business leaders and their businesses, they can take a risk by offering credit to their customers. Once a business offers credit they are taking the risk of their customers not paying back their debt. Many small businesses will offer a standard rate to cover against that risk. For example, they would offer an 18% rate to hedge against that risk. Many small businesses would also offer an incentive to their customers by giving them a 2% discount if they pay within 10 days after the closing date of their statement. For credit card companies or banks that loan money, they would offer a wide range of rates that is based on someone’s credit score to hedge against the risk of not being repaid. The higher the risk a borrower is, the higher the rate the creditor is going to offer the terms to. At the end of the day, the businesses must protect themselves to make sure they are being repaid. They will need these funds to continue their operations, and they make these decisions to hedge against someone who may not repay their loan.

Another form of risk a business can take is developing another product, going into another market, or even buying another company to increase their market share. The risk of all three of these is that they can fail, and the results would not have a positive outcome.

A business can respond a variety of ways when the risk they take does not turned out the way they expected. In our current market today in regards to the housing market, many banks have changed their underwriting policy in relationship to home loans by tightening up their credit standards or stopped underwriting all together. Yet some have cut and run, because they are afraid of the continue downturn of their businesses and closed their home loans businesses all together. Business leaders must make rational and wise decisions in regards to making business decisions, because others may be impacted e.g. employees or stockholders. When it is all said and done, business leaders must not make their decisions based on emotions but based on careful analytical study of the situation they are in.

There are decisions that a family faces that have risks. One of the most common decisions a family or someone can make, is how to invest in the stock market or in the housing market. One must understand how these markets work and understand the basic fundamentals of investing in these two areas. One would need to do the necessary homework and careful study of the investment they are going to make, so they can have profitable returns. One must realize that the markets will have its peaks and valleys, and that not all markets e.g. stocks or houses will continue to rise. In order for one to hedge against the risk of investing in the stock market, they must do their homework and have a diversify portfolio to hedge against the downturn of stock(s). One should not react emotionally or prematurely when a stock goes down or when there is news of a certain stock, but one response should be of patience.

And if one wants to invest in the housing market, one must do their homework of the conditions of the market and rent the property to those who are able to (a credit check should be done). One must charge enough rent to cover against any future loss if the rentor decides to leave and you are unable to recoup the rent.

Another risk one can face is that someone may be laid off. If one is laid off, there will be no incoming cash flow that will meet the monthly livelihood expenses e.g. rent or mortgage, utilities, medical, or food. Therefore, one should hedge against this risk is to build a reserve of excess cash in a safe money market account that is not tied in at your local bank that you can have easy access to. If one does have easy access to it, the temptation of using the reserve will be greater. It is suggested for one to build a reserve that is greater than six months of your committed expenses.

There are a few things that have caused our economy and financial markets to get riskier. One is the continuous threat of a terrorist attack on our homeland or terrorist attack on our computer networks. If such event occurs, our markets will sell off and billions can be wiped out of the market place. Another one can be risky and unwise investments by businesses or liberal or lax credit underwriting (or loans) that we are currently facing right now. Another can be the 24 hours news stations, which report instant news that can be broadcast throughout the world in matter of minutes. If the news is negative e.g. bad economic news, terrorist attack, or any other negative connotation that can cause an emotional response that can lead to market downturn and a market selloff or news that is broadcast that things are doom and that there is no hope, can change the American mentality to a negative view of things.

As individuals and businesses, we must make the necessary means and methods to meet against the negative economic headwinds or cyclical economic downturns. Therefore, I would suggest individuals and businesses approach all financial decisions in investments with a conservative approach. And build their liquidity as an insurance against economic downturns. If one builds this reserve, one will come out strong on the other side of the economic downturn. As far as risk, on must control their emotions and build a risk tolerance and not make irrational and emotional decisions.