Risk management is the process of analyzing exposure to risk and determining how to best handle such exposure. In many cases, the solution to managing risk is purchasing insurance or hedging. But, in other cases, the appropriate form of risk management is to do nothing. PWA helps you decide the strategy that is right for you.
One of the easiest ways for a financial plan to fail to achieve its goals is to fail to properly manage the risk associated with the components of that plan. You could have been successful in saving for a down payment on your dream house for 5 years, only to accidentally injure someone in an auto accident and get sued for a million dollars in punitive damages (most people don't realize that their auto liability insurance may only cover the first $100,000 of that award). So much for that house. Now you're looking for a bankruptcy attorney instead. There are numerous threats to a financial plan. In order to minimize the risk of failure, they must each be addressed.
We examine your current situation and lifestyle and determine the threats to your financial goals. Some of these threats would be catastrophic in nature (income provider dies, the auto accident described above, etc.). Others would be minor. Some have a high probability of occurring, others a low one. The principles of risk management help to decide what to do about particular risks. Consider the chart to the right which segments threats into four potential categories:
High probability / High Severity - these threats are potentially catastrophic to the plan if they occur, and they are likely to occur often. Examples are car accidents if you drive drunk, or home damage if you live in hurricane prone areas. The proper risk management strategy here is to avoid exposure to these threats by changing behavior (i.e. don't drive drunk or live in hurricane areas).
High probability / Low Severity - these threats occur often, but are unlikely to be very costly in nature on their own. An example is living in NYC and having your hubcaps stolen from your car. The solution is typically to think of a way to reduce the risk without avoiding the behavior. You're not going to move from New York over hubcaps but you could buy a device that locks the hubcap to the wheel.
Low probability / Low Severity - these threats are very minor in nature. They don't occur often and when they do, they're not severe. Examples are door dings to your car, or road wear to your tires. The risk management strategy is to accept the risk and do nothing.
Low probability / High Severity - these are the threats that are managed well through insurance. They occur rarely, so we don't want to avoid the activity altogether, but when they do occur, they can be catastrophic. To stay with the car example, this type of threat would be a car accident while driving to work. We don't want to stop driving all together, and there's not much besides defensive driving we can do to avoid the accident. So instead, we pay an insurance company and transfer the risk to them
We help you manage these types of decisions as well as those pertaining to your portfolio, retirement, and estate. Some threats are handled through insurance, some through hedging, some through proper planning, and others through behavioral change. In the case of insurance, we'll analyze the need for life, health, disability, long-term care, homeowners, auto, and umbrella policies. We do not believe insurance is the best risk-mitigation strategy in all cases, but it is necessary in some. We'll also manage your portfolio based on your risk tolerance and employ financial techniques that can limit or reduce (but never remove) your downside risk. Would you be willing to sacrifice approximately 1% of your return each year to guarantee your stock portfolio never falls by more than 20% in any given year? Some people may, but it's unlikely that a stock broker or asset manager focused on maximizing your return would ever off you that opportunity to hedge (which is a real opportunity in the options market).
Managing risk is one of the more difficult things for most people to do. The natural reaction is to avoid the activity that introduced the risk, or ignore the risk totally. Many people are hesitant to buy insurance because they're afraid of being scammed. Having an unbiased advisor that doesn't profit from your policy decisions and who isn't incented to take extraordinary risks in your investments can be beneficial not only to your finances, but also to letting you sleep peacefully. PWA is that unbiased advisor, and we want to help you.
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