Four Ways to Manage Risk

Four Ways to Manage Risk

Every risk we face can be addressed in one of four ways. Each may be an appropriate choice, depending on the circumstances and type of risk in question: Avoidance Reduction Transfer Retention Avoiding Risk The surest way to prevent the potential loss arising from a certain activity is to completely avoid it. For example, if I want to avoid the possibility of having to pay for a stranger’s medical expenses due to an auto accident, I could stop driving a car. So why not just avoid all risks? The problem is that whenever we avoid a risk we also miss out on the benefits we could have received for participating in the associated activity. In addition, not all risks can be completely avoided, such as the risks of illness or natural disaster. Avoidance may be appropriate for a limited number of risks that produce a high probability of loss, such as gambling, but it is not a practical solution for most risks. In some cases we may even create additional risks by trying to avoid a particular risk. For example, we may be tempted to keep all of our savings in cash to avoid the risk of investment losses, but then we would be subjecting ourselves to the potential risk of loss by inflation, which is practically guaranteed to significantly erode the value of our cash over time. Reducing Risk  If we are unable or unwilling to avoid an activity, we can take steps to reduce the probability and potential severity of loss associated with the activity. For example, when we choose to drive, we can reduce the risk...