The Ways of Risk Management

This is Part 3 of my blog series: The Art & Science of Risk Management

In my previous post I suggested that risk management is a mental exercise that with enough practice adds great value to our lives without it being onerous. The whole purpose of this blog series is to help with that practice in life and in business. On that note, I would like to further educate you in the various ways we can manage risk.

There are 5 main ways to manage risk: exploitation, acceptance, avoidance, transference and mitigation. These must be considered, individually or in combination, before taking any action toward an objective alongside the various methods of thinking indicated in my previous post: prepare for the worst, paint the full picture, know your limits, re-evaluate your expectations, integrate your thinking and pay attention to risk advice. It is also important to remember risk management is an ongoing exercise done throughout the journey toward an objective.

Exploit the risk

As suggested in my previous post, reward does not usually come without risk and they also tend to be proportional to one another. We may therefore want to strategically exploit or take on the risk to yield a reward. Our risk appetite will determine which risks we will exploit. If, for example, we are risk lovers then we will invest in cryptocurrencies as they are high risk and therefore high reward. Conversely, if we are risk averse, we will simply open a savings account, which is low risk and therefore low reward.

Accept the risk

Accepting the risk is much like exploitation of the risk in that in both ways we choosing to take on the risk. The difference however is that accepting the risk is not associated with any expected reward. We usually accept risks that we perceive as small, like driving our cars to work. Its therefore clear to see that we accept risks every day. We may also receive a reward unexpectedly when accepting risk – this we call a positive risk.

Avoid the risk

Some risks are too high to accept. In these cases, we will do our best to avoid them. For example, climbing Mount Everest is far too much risk for most and so we avoid it by not climbing it. There are also risks which may be not so high but you may just want to avoid them anyway because you can, like a fiery argument with someone you love. Where we can’t avoid risks, we must either mitigate or transfer them.

Mitigate the risk

Mitigating risk is synonymous to risk reduction. Risk mitigation is much like risk exploitation or risk acceptance, but with the condition that we will only choose to take on the risk if we can mitigate it somewhat. For example, we may be willing to swim in icy-cold water but only if we have the appropriate winter swimwear. We also mitigate risk by wearing a helmet in situations that require head protection.

Transfer the risk

We may have the opportunity to transfer the risk to another party and said party may be willing to accept our risk at a price. Taking out insurance is a form of risk transfer.