Managing money is like sailing a boat—you must be prepared for sudden waves and unpredictable weather. Different financial risks impact our savings, investments, and overall financial well-being throughout life. In this guide, we’ll explore five common financial risks, provide relatable examples, and offer practical ways to address them.
What is Financial Risk?
Financial risk is the possibility of something unexpected that could negatively impact your money or financial plans. Just like you can’t control the weather while sailing, you can’t always predict financial challenges—but you can prepare for them!
Types of Financial Risks
Financial risks come in different forms. Some are caused by rising prices, changing interest rates, sudden job loss, unexpected expenses, or difficulty accessing cash when needed. Understanding these risks can help you make more informed financial decisions and build a more secure future.
1. Inflation Risk: The Silent Erosion of Money’s Value
What is it? Inflation occurs when the cost of goods and services increases over time, causing a reduction in the purchasing power of your money. Simply put, the same amount of money buys fewer things over time.
Example: Sameer saves ₹10,000 for a future trip. A year later, the cost of travel and hotel stays has increased. His ₹10,000 isn’t enough anymore. That’s inflation at work!
How to manage it?
- Invest in assets that grow with inflation, such as equity mutual funds, real estate, or gold.
- Avoid keeping too much money in savings accounts, which lose value over time.
- Plan for long-term financial goals by factoring in inflation to account for its impact.
2. Interest Rate Risk: The Cost of Borrowing and Saving
What is it? Interest rates affect everything—from the EMI on your loans to the returns on your savings and fixed deposits. When rates change, your financial plans may need adjustments.
Example: Rani takes a home loan of ₹1 lakh. If interest rates rise, her monthly EMI increases, making repayment difficult. On the other hand, if rates drop, she earns less from her fixed deposits.
How to manage it?
- Opt for fixed-rate loans when interest rates are low to lock in lower monthly instalments (EMIs).
- Diversify investments to include assets that perform well in different interest rate cycles.
- Keep an emergency fund so you’re not forced to borrow at high rates.
3. Income Risk: The Uncertainty of Earning Money
What is it? Income risk refers to the uncertainty of your earnings due to job loss, pay cuts, or career changes.
Example: Rahul works at a retail store. If the store shuts down or he loses his job, he suddenly has no income. This makes it hard to pay for daily expenses and EMIs.
How to manage it?
- Build an emergency fund with at least 6 to 12 months of living expenses.
- Invest in multiple income streams (freelancing, rentals, dividends, etc.).
- Continuously upgrade your skills to stay employable.
4. Personal Risk: Unexpected Life Events
What is it? Unexpected medical emergencies, accidents, or disabilities can result in significant financial burdens.
Example: Anita suddenly falls ill and requires expensive treatment. She struggles to cover medical bills without health insurance, which affects her financial stability.
How to manage it?
- Get health insurance with adequate coverage.
- Have a separate emergency fund for medical expenses.
- Consider life insurance if you have dependents.
5. Liquidity Risk: When You Can’t Access Cash Easily
What is it? Liquidity risk arises when you can’t quickly convert assets into cash without losing value.
Example: Raj invests in real estate and expects good returns. But when he urgently needs money, selling his property takes time and may force him to sell at a loss.
How to manage it?
- Maintain a balance between long-term investments and easily accessible funds.
- Keep a portion of your savings in liquid assets, such as emergency funds and short-term deposits.
- Diversify investments to include assets that can be sold quickly.
Final Thoughts
Understanding these financial risks is like preparing for different weather conditions on a long journey. You can’t control everything, but by having the right strategies in place, you can navigate financial challenges smoothly.
To build a strong financial future:
- Stay informed about inflation, interest rates, and income stability.
- Protect yourself with insurance and maintain a savings or emergency fund.
- Diversify investments to reduce risks.
By planning, you can confidently steer through financial uncertainties and secure a prosperous future. The goal isn’t to eliminate all risks—it’s to manage them wisely!
Disclaimer: The information provided in this blog is for educational and informational purposes only and should not be considered as financial, investment, or tax advice. While every effort has been made to ensure accuracy, readers must consult a qualified financial advisor before making investment decisions. VSJ FinMart is an AMFI-registered mutual fund distributor (MFD) that does not provide investment advisory services. Mutual fund investments are subject to market risks; please read all scheme-related documents carefully before investing.