 What does Financial Risk mean?
Seeking for a definition Click to read
By Financial Risk, we usually refer to a form of risk emerging from an event, situation, dynamic that might negatively impact people’s financial status quo.
The cluster of potential events from which the financial risk might arise from are numerous and very diverse among each others.
Specialised literature offers many different taxonomy to describe the most typical types of Financial Risk. In the content of this module, the taxonomy of risk is structured so as to guide learners throng the most common risks that one might experience while managing his / her personal finances.
Four main clusters of Financial Risks Click to read
| General Financial Risk |
Individual Financial Risk |
Time-based Financial Risk |
Impact-based Financial Risk |
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When we talk about General Financial Risk, we refer to any event that might generate a loss.
This type of risk is essentially related to the origin and source of the triggering event.
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This Risk pertains to the person very own finances and it might be generated by poor judgements and / or and overestimation of favorable trends and dynamics
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Financial Risks can be also categorized based on the timeframe involved and considered.
There is no easy way to estimate their impact, and as in some cases, their likelihood at all
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Depending on the domain interested by the risk, people might face several negative outcomes that again might be simple consequence of bad luck, or poor judgement
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General Financial Risks Click to read
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Systemic Financial Risk
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Non-Systemic Financial Risk
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In broad terms, Systemic Financial Risk generates from events that affect and impact all people and from which you cannot escape from.
As the term implies, Systemic Financial Risk stems from triggers that impact the socio-economic ecosystem as a whole (i.e., instable political climate) and translates topically into increased Market Volatility (less capacity to foreseen and “decode” future market trends), increased interest rates (less capacity to access the credit market), increased taxes (less purchasing power).
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In this case we refer to events that might potentially affect the person only – or its closest groups of reference (the organisation he works for, family, etc.).
Typical Non-systemic financial Risk scenarios are represented by a sudden illness, a sudden malfunctioning of a machinery, etc.
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Individual Financial Risks Click to read
| Income Risk |
Expenditure Risk |
Investment Risk |
Debt Risk |
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Income Risk might relate to a series of event that affect work-ability of the person, and ultimately his / her capacity to earn an income
Typical instances of Income Risk emerge in case of:
- Physical disability
- Dismissal
- Any other event excluding a person from the labor market
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More simply, when the expenditures that arise in a given period exceed the money available to cover them (when there is no sufficient money to meet the financial / economic needs)
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In this category we include any event related to depreciating of the asset owned by a person so much so that its value goes below the original price payed for its purchase
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The typical case is when people remains trapped to debts with high interest rates, or more in general, when they are no more able to afford the repayment of their debt
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Time-based Financial Risks Click to read
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Short-Term Financial Risk
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Long-Term Financial Risk
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That’s the type of financial risk that arise in a relatively short period of time and that is difficult to predict (i.e., any sudden expense that is not included the budget).
Short-term financial risk requires typically the full disposal of a certain money in a very short and concise period of time, weakening the personal savings of a person and the very same availability of this money for other purposes (i.e., saving, investment, etc.)
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We talk about long-term financial risk impacts the long-term financial sustainability of a person and has much greater consequences for his / her economic stability.
This is the case for instance when families lose their main and only source of income due to the sudden (or gradual) inability to work of the only person responsible for the (economic) sustainment of the family.
Please note that the term “long-term” refers to the temporal horizon of the effects and impact of the event, and not its actual happening in time.
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Impact-based Financial Risks Click to read
| Speculative Risk |
Fundamental Risk |
Static Risk |
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This is the typical case of any sort of investment: people commit a certain among of money to a certain thing, in the hope that, at some point, this thing will generate more money that what it actually costed.
In general the elements of risk is inalienable from any type of investment, and it exists by default. The real issue come into play when either it is underestimated, not duly consider, or more simply ignored.
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When the events generating from the risk impact one person specifically, and the people around him / her at max, we talk about “specific risk”, meaning: the negative outcomes of the event has not negative repercussions outside of the people directly involved.
Examples of fundamental risks are more common for instance when managing household expenses.
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Static Risk refers to a financial loss that might be caused by any non-economy related / systemic event. The triggering event happens in the here and now and it is typically covered by an insurance
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Dynamic Risk
It depends on macroeconomic events which have a direct impact on one’s personal finances – whatever he / she likes it or not…(i.e., inflation, higher cost of raw materials)
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How do you mitigate the financial risk?
A four-dimension approach Click to read
Where there is a risk, there is also a countermeasure. To some extent, many forms of Financial Risk can be predicted, or at least estimated.
Risk Management is first of all a matter of planning: being aware of the risk is halfway through the opera of covering and safeguarding yourself from unpleasant and disrupting scenarios.
For an effective Risk Management, one must intervene on the five key financial elements from which the risk might arise:
| REVENUE |
EXPENDITURE |
ASSETS/INVESTMENT |
DEBT vs CREDIT |
SURROUNDINGS |
Revenue Management Click to read
Be ready for a plan B…
- Monitor your revenue stream(s)
Do not forget to set up a safety net so as to face with relative ease all short-term risks.
An insurance is the most robust and reliable resource that one might consider to delegate to others his / her own financial risk.
Expenditure Management Click to read
A domestic budget will help you to plan more carefully all expenses, cutting wastes away if necessary.
- Planning an emergency gateway
A safety net helps you to contain the negative impact of a unexpected expenditure, an emergency fund is unlocked, indeed, in cases of emergencies - so to say, when no other option is available.
Asset/Investment Management Click to read
- Be careful where you put your money on...
As redundant as it sounds, this remains the most crucial & critical recommendation – do you really know, and own, the necessary knowledge regarding that specific asset that you are betting own?
- Set a goal and aim for it
This goes back to the fundamental need of having an adequate medium-long term oriented plan for investments: monitor your progresses and keep track of suitable fine-tuning measures.
Debt/Credit Management Click to read
- Get familiar with the financial flows
Become proficient with the distinctive features of credit and debt (i.e., interest rate)
- Know when to deep-dive into the ocean of debit
If you are not ready to go into debt, do not go into debt – even more if the need for credit is motivated by futile needs. Assess your exposure in advance, and evaluate you capacity to cover your repayment plan.
Social awareness of the surroundings Click to read
Do not reply to suspicious eMail, let alone downloading their contents and attachments. Fraudulent eMail are the most common means used by cyber-criminals to infiltrate the victim’s personal and sensible data.
- Debit and Credit Card Fraud
Fraudulent activity that involves a theft taking the number of a credit or debit card – do not share sensible information unless strictly, check as frequent as possible outgoing / incoming flows of money from / to your account.
Internet fraud happens when someone uses the internet as a tool to take advantage of someone else through fraud. Online internet schemes nowadays are the most common type of frauds, stealing millions of dollars from victims each and every year.
Summing up
Summing up Click to read
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Types of Financial Risks
- General
- Individual
- Tim-based
- Impact-based
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Planning a countermeasure
- Revenue
- Expenditure
- Asset/ Investment
- Debt/Credit
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