Yaayaatu dharma kaamaarthaan
Dhrutyaadhaarayaterjuna
Prasangenaphalaakaankshi
Dhritissa paartha raajasi

That is, “To acquire money people have great fortitude. A person who has attachment to acquire wealth or power, also requires a lot of dhriti i.e. the ability to hold on to our motto, our goals.”

Multidimensional
Risk is multidimensional and is all about personal positioning and thinking. For example, a salaried person takes less financial risk as his remuneration is fixed but he takes the biggest risk-“the risk of De-Growth”. While in employment one can never move to be Bill Gates, Azim Premji, Narayan Murthy or Dhirubhai Ambani.

“No risk no gain is a truth of life”.
In life as in business there is no clear way to avoid risk taking. Risk is part of our personal and corporative life. It spans from the level of personal safety, health, accident and employment to corporate asset depreciation, production, inflation, foreign exchange rates, etc.
However, risk can be assessed, warded and managed through proper analysis and planning.

What is risk?
A risk situation occurs when we are required to make a choice between two or more alternatives whose potential outcomes are uncertain and must be subjectively evaluated. A risk situation involves potential success and potential loss. The greater the possible loss or profit, the greater the risk involved.

Types of risk
Risk situations are characterized by the presence of uncertain events as follows:

• PURE RISK- Sometimes we face risks with no chance of profit and the best we can hope in this cases is not loss. This kind of risk is called pure risk. Hailstorms, earthquakes, hurricanes, dry seasons, and other natural hazards are considered pure risks.
• SPECULATIVE RISK- At times the decision taken can lead to additional profits or alternatively could deal with non-profit or losses. This kind of risk is called speculative risk, when risk involves the chance of making a profit or taking a loss.

Shri B.L. Mittal FCA, FCS, FCWA. This paper was originally presented at the All India Members Conference on the theme ‘Corporate India – The Superpower Summit 2003’ organised by Committee for Members in Industry of ICAI and hosted by EIRC of ICAI. Views expressed/given in the Knowledge Portal are that of the experts concerned and not of the Continuing Professional Education Committee or of the Institute of Chartered Accountants of India.

• FUNDAMENTAL RISK-Risk that affects the entire economy or a large sector of people or groups etc. is called fundamental risk. Inflation, wars, recession etc. are considered fundamental risks.
• PARTICULAR RISK-Risk that affects a particular person or a particular business instead of the entire community, country, industry is called particular risk. Premature death, labour problems etc. are some of the examples.

AS A PERSON ONE IS EXPOSED TO -

Personal Risk
Risk of premature death
Insufficient retirement income
Poor health

Property Risk
Damage by fire, flood etc.
L oss by theft, robbery etc.
Property rights

Liability Risk
You may be liable to others for your Unemployment/inadequate earnings change in law adversely affecting conduct (professional or otherwise)

• Critical illness
• Partial disablement
• Full disablement
  

Risk management
Risk is inevitable, one has to take risk in life whether by choice or otherwise. However, risk can be controlled & managed through “risk management”.

Risk management is a discipline for dealing with the possibility that some future event will cause harm. It provides strategies, techniques, and an approach to recognizing and confronting any threat faced by anybody in fulfilling its mission. Risk management may be as uncomplicated as asking and answering three basic questions:

• What can go wrong?
• What will we do (both to prevent the harm from occurring and in the aftermath of an "incident")?
• If something happens, how will we pay for it?

  It provides a disciplined environment for proactive decision making to

• assess continuously what could go wrong (risks)
• determine which risks are important to deal with
• implement strategies to deal with those risks

The Risk Management Paradigm is depicted below

Functions of Risk Management
Each risk nominally goes through these functions sequentially, but the activity occurs continuously, concurrently (e.g., risks are tracked in parallel while new risks are identified and analyzed), and iteratively (e.g., the mitigation plan for one risk may yield another risk)

All risks need rational consideration, and some must be accepted. Sooner or later, it will be pointed out that a few head injuries occur to pedestrians, but I hope that it will never be made mandatory to wear a helmet to take a walk.

Instruments For Risk Management
A well developed financial system offers a variety of tools for risk management, assessment & control.
The three basic methods are:

• HEDGING - Hedging is a way of reducing some of the risk involved in holding an investment. A hedge is just a way of insuring an investment against risk. It entails moving from a risky asset to a risk less asset. One of the ways of hedging is entering into a forward contract.
• DIVERSIFICATION - A portfolio strategy designed to reduce exposure to risk by combining a variety of investments, such as stocks, bonds, and real estate, which are unlikely to all move in the same direction. It has the same benefits as accrues in case of putting eggs in different baskets instead of putting them in the same basket. Diversification reduces both the upside and downside potential and allows for more consistent performance under a wide range of economic conditions.
• INSURANCE - This is the most common tool of risk management. Here risk is transferred from the insured to the insurer. The insured retains the economic benefits of ownership while laying off the possible losses in lieu of a fees or insurance premium to be paid by the insured to the insurer.
  

RISK & WEALTH

"Financial success is attained through what you do with your income, not through how much you earn."

Over a lifetime, most people will experience many different financial needs and circumstances that can be summarized into three stages: risk management, wealth accumulation, and wealth preservation and distribution.

Expert Guidance . . . for a lifetime of financial needs

In risk management, the foundation of financial plans, you protect that which you can least afford to lose—your earning power.The foundation firmly in place can help you accumulate wealth, there being a strong direct link between risk & wealth. Higher the risk, higher may be the opportunity to earn which is illustrated as follows:Consider two people. Each saves Rs.36000 per year, but multiplies it at different rates. Person A is very risk averse. He puts all his money in fixed income securities and earns 8% returns. The other person B employs a diversified portfolio and earns 12% interest. The following table gives a picture of how money multiplies in both cases. A’s total savings at the end of 25 years is Rs.28.78 Lacs while B’s wealth is Rs.54 lacs, about 85% more than A’s. It is important to recognize the difference between income & wealth. The key is to invest the amount wisely so that wealth grows with Age.

Savings of Rs.36000 every year

Process of risk management

The Essence

“The essence of risk management lies in maximizing the areas where we have some control over the outcome while minimizing the areas where we have absolutely no control over the outcome.”
Peter L Bernstein

The Process

Step 1-Identify & Evaluate Potential Requirements & Risks

First step towards risk management is identifying your financial requirements and the risks you are exposed to.
The potential requirements of an individual can be listed down as follows:

• Earning to meet regular consumption needs
• Funds required for
• Self education & development
• Housing
• Car
• Children’s education & marriage
• Parental care
• Other family obligations
• Medical emergencies
• Mission funding
• Plans to start own business
• Charity
• Funds for own business/profession

The risk exposures for an individual can be summarized as follows:

• Death
• Accident
• Illness
• Critical illness
• Loss of employment
• Retirement
• Property risk
• Liability risk

Step 2- Evaluation Of Attitude Towards Requirement & Risk
Assessment of attitude towards risk & your money is a prerequisite to financial planning of an individual.
Take this exercise to check your attitude.
The entire exercise depends upon following three factors:

1. Requirement
2. Risk taking ability
3. Emotional tolerance

   1) Your financial requirements are

   High
   Average
   Low

   2) You assess your risk taking ability as

   High
   Average
   Low

   3) Your emotional tolerance is considered as

   High
   Average
   Low

   Assign the following points to your answers:
   
   High
   Average
   Low

   Financial Requirement
   4
   2
   1
   
   Risk Taking Capacity
   5
   2
   1
   
   Emotional Tolerance
   4
   2
   1
   
   Your score decides for you:

   • 11 –13 – If you have scored between 11 and 13 it suggests an Offensive attitude towards your investments with a high risk taking capacity. Therefore the “high risk high gain” probability works in your favour.
   • 7-10- If you have scored in the range of 7 to 10 you can be classified as an investor with a moderate attitude which suggests that a safe ratio of risky & risk less investments builds the right kind of portfolio for you.
   • Below 7-Your score below 7 says it all. You have a highly defensive attitude towards your money. Low risk taking & low emotional tolerance suggests investments with fixed & secured returns for your portfolio even if they are not so high.

Step 3-Study & discussNext step is to study and discuss various financial aspects concerning an individual to draw a suitable financial plan.

Step 4-Selection Of Appropriate TechniqueBased on your attitude (as evaluated above) and financial needs one should frame strategic and financial alternatives specifically designed to suit the needs for a secured financial future.

Step 5- ActionOnce your personal financial strategy is decided, action should be taken upon so as to build your well diversified portfolio suiting your financial appetite.

Constant review

In today’s ever-changing scenario with new opportunities coming up & changing financial needs one constant solution does not suffice. Therefore your portfolio requires monitoring and review periodically so that adjustments can be made, if necessary, to assure that it continues to move you towards your financial goals and risk management.