The risk-averse investor loses any potential gains the oil stock could have. On the other hand, the investor who reduces his risk still has potential profits. If the stock market rises, its long positions will increase in value. However, if his positions lose value, he is protected by his put options. Another example can occur when a bank plans to expand its product to meet the needs of a particular category of the economy. Once the business plan and offer are completed, the bank determines that the plan is risky and decides not to pursue that strategy or product. You strategically avoided the activity so that the loss did not occur. Risk prevention and mitigation are two risk management strategies. Risk prevention is the elimination of any exposure to risk that represents a potential loss, while risk mitigation is the reduction of the likelihood and severity of a possible loss. This article explores the differences between the two approaches.
Risk avoidance and elimination are often summarized: Unlike risk mitigation, investors who choose to avoid risk altogether will divest themselves of certain investments and completely change their strategy. Examples of risk avoidance can be found in all sectors: Suppose an investor wants to buy shares in an oil company, but oil prices have fallen significantly in recent months. There are political risks associated with oil production and credit risks associated with the oil company. When an investor assesses the risks associated with the oil industry and decides to avoid participating in the business, it is called risk avoidance. Today`s challenge: When there are risks, there are gains. Is risk avoidance more of a business a hindrance than a business`s survival? In order to manage risk, an individual or organization must quantify and understand its liabilities. This financial risk assessment is one of the most important and challenging aspects of a risk management plan. However, for the well-being of your wealth, it is crucial to ensure that you understand the full extent of your risks. For example, if you have multiple sources of income, losing electricity won`t hurt as much if only 25% of a person`s income comes from that stream. Risk prevention is the elimination of hazards, activities and exposures that can have a negative impact on an organization and its assets.
Seeks a “best of both worlds” approach to mitigating risk while exposing yourself to potentially high returns We discussed at length a financing and loss mitigation technique by explaining risk-sharing and transfer approaches. Today, we will focus on another financing and loss control technique – RISK RETENTION AND AVOIDANCE. There are four main risk management strategies or risk treatment options that business leaders can take to address the variety of risks identified: Financial diversification is one of the most reliable risk mitigation strategies. When your financial risk is diversified, unwanted side effects are diluted. Organizational leaders typically decide to avoid risk when the risk itself has the potential to cause catastrophic damage to the organization and/or the cost of mitigating the risks outweighs the benefits. Companies are exposed to many different risks. Some risks can cause significant and widespread damage to an organization, while others can only cause limited damage. Executives take a more moderate approach when pursuing a risk mitigation or transfer strategy. A risk transfer strategy follows similar steps; However, as part of a risk transfer strategy, a third party is paid to bear some or all of the costs and consequences if the risk causes harm or harm – and if it does not.
Like all risk mitigation strategies, the decision to avoid risks has advantages and disadvantages. On the other hand, risk mitigation is the process of mitigating potential losses through a tiered approach. Suppose an investor already owns oil stocks. Both of the factors discussed above remain relevant: there are political risks associated with oil production, and oil inventories often present a high degree of unsystematic risk. Unlike a risk avoidance strategy, this investor can reduce risk by diversifying their portfolio by holding their oil stocks while buying stocks in other industries, especially those that tend to move in the opposite direction to oil stocks. Since risk avoidance is a deliberate tactic, it is not the same as not recognizing a risk or ignoring it altogether. Investors could, for example, avoid any risk of loss of capital value by placing all assets in a government-backed savings account instead of buying shares whose value would likely fluctuate. Not all transactions are necessarily approved.
A reduction (risk avoidance) may be your best choiceâ Each investor should weigh the current scenario and level of risk and decide whether prevention and mitigation strategies are best suited to the investment style and portfolio. Financial institutions use a combination of techniques to manage their risks and select the strategies that best suit their industry. Whatever decision is made from time to time, it is imperative to do so consciously and to keep a diary (register) of these decisions as a reference for future decisions. Risk prevention is a specific type of approach to risk management that requires a methodical process. Leaders need to identify and assess the risks facing their organization and determine how to eliminate the likelihood of those risks causing damage to the organization. Companies make the decision to retain risk when a cost analysis shows that it is cost-effective to manage the risk internally, as opposed to the cost of full or partial insurance against it. Companies choose to retain risk when the premium for their transfer is significantly high. You could rename the risk retention approach to self-insurance. Frameworks typically assess the likelihood and negative impact of an identified risk against the respective benefits, disadvantages and costs of the four risk management options listed above.