Balancing Personal Financial Risks and Rewards
Consumer Advocate Shares Strategies for Minimizing Risks to Personal Financial Security Ahead of Life’s Unexpected Challenges
Unforeseen, costly emergencies and expenses are often a fact of life. That doesn’t mean there aren’t steps consumers should take to minimize their impact and ensure personal financial security. According to Certified Financial Planner Board of Standards Consumer Advocate Eleanor Blayney, CFP®, limiting exposure to risk and getting the right insurance is crucial to protecting one’s financial well-being.
“It's just as important to protect our finances – or indeed anything we value – from loss, as it is to grow our wealth,” says Blayney. “Without taking steps to minimize risks to our financial security, all the wealth we spend so much time planning for and building can be quickly eliminated by one of life’s unexpected but inevitable disasters.”
Managing risk is one of the 12 steps in CFP Board’s year-long “12 for ’12 Approach to Financial Confidence.” Blayney recommends three key strategies consumers can use to protect their financial worth ahead of life’s “Mayday!” events.
- Avoid unnecessary risk. Avoiding risk is generally the simplest, cheapest approach to protecting wealth. But it can also be impractical, inconvenient, and even ill-advised to preserve your finances, but sacrifice any upside. For example, staying out of equities to avoid the risk of a drop in the stock market may mean missing long-term benefits from the overall trend of stock market gains. It’s critical to assess risk and reward in the short- and long-term.
- Mitigate risk. Take steps to reduce the probability and impact of financial loss, such as diversifying a 401(k) or investment portfolio. Lower the financial costs of a loss by creating an emergency fund for unexpected expenses or job loss. The costs and long-term consequences of drawing money from a reserve account are considerably less than resorting to credit cards or simply letting expenses go unpaid.
- Purchase insurance. Insurance spreads risk out to a third party for a lower price than you would pay if an unexpected event occurred and you were solely responsible. Getting insurance coverage is a necessary part of building financial security for anyone who provides support or cares for another individual; must work for a living; or has a home, a car or valuable property.
There are five cardinal rules for the prudent use of insurance:
- Insure only what you cannot afford to lose. Consider your personal circumstances and determine what assets and services would be financially devastating to lose. From life and disability income insurance to long-term care and health insurance, purchase insurance that will ensure your most vital needs are maintained.
- Use insurance for financial, not emotional, loss. While the loss of a beloved personal item would be devastating, the reality is that it may not result in a significant financial loss and insurance may not be necessary. Insurance for children should be considered in certain cases, but may not be suitable for most.
- Focus on acquiring insurance that offers the best protection from loss, rather than extraneous benefits. Insurance is first and foremost to protect assets, not grow them.
- Keep insurance costs down through the other risk management strategies. Proactive life adjustments such as installing a home security system (a form of risk mitigation) or quitting smoking (risk avoidance) can significantly reduce your insurance premiums.
- Consider self-insurance in combination with commercial insurance. Raising policy deductibles or extending the time before one can make a claim on a disability or long-term care policy may lower overall insurance costs.
“Finding the right type of insurance for your needs and lifestyle is complicated,” says Blayney. “A CFP® professional will help you identify the right mix of coverage and other risk management strategies to balance risk with your current financial situation and future goals, and prepare a plan that both protects and grows your financial resources.”
12 for ’12 APPROACH TO FINANCIAL CONFIDENCE
In January, CFP Board launched a new initiative called “12 for ’12 Approach to Financial Confidence” where all the components and steps for successful personal financial management are presented, one each month throughout the year including: establishing realistic goals, tax planning, emergency and risk management, investing, retirement, debt management and estate planning.
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