Ways to manage financial risk | Insurance | Financial literacy | Khan Academy

So, let's talk a little bit about the different ways that you can manage risk. It's generally going to fall into a few categories. You can obviously try to avoid the risk altogether or reduce it. You could say, "Alright, that risk is there, but I'm going to retain the risk, and then how can I manage that?" Or you can actually transfer that risk to someone else. We're going to talk about all of those.

Let's just pick a particular type of risk. Let's say one risk, one financial risk is your loss of income. What happens if you lose your job? Or if you run a business, what happens if the business goes under or it has lower income for some period of time?

Well, the first strategy is obviously to avoid that as much as possible or to reduce the probability of that as much as possible. So, if you're at a job, try to perform well at your job. If they're firing folks or if they're doing layoffs, you are a crucial employee that they can't let go. That is a good way of avoiding or at least reducing your risk.

You can't completely avoid your risk; things happen in the economy. No matter how good you are at work, sometimes you can get fired; you can get laid off. So, always keep that in mind. But obviously, we all want to reduce that as much as possible. Now that risk is there, you're not going to be able to completely get it, so to some degree, you are going to retain some of that financial risk.

If you're taking that financial risk on, as we've talked about in the other videos, one of the best ways to protect yourself is by saving money. I would say a combination of saving money and living below your means, or having a very quick way of being able to live below your means, if by chance you were to lose your income. Because if you do that, you have more time; you could live off of your savings, especially if you don't spend a lot to live, and you have time to transition to something else.

Now, you can also transfer the risk to others, and that's usually through some form of insurance. There are government unemployment benefits, but oftentimes that's not going to be enough to cover your expenses. There are other types of unemployment insurance that you might be able to get; that's a little bit less common for people to get. You know, unemployment insurance above and beyond that.

So, most folks, when it comes to loss of income, let's avoid it or minimize the chances of that happening. But then also create a nest egg. There are other forms of risk that we've talked about, like liability. What happens if someone sues you because there's a car accident, and you're at fault, or at least the judge decides that you're at fault, and then you owe them a lot of money in a lawsuit?

Well, once again, the best thing to do is to avoid or reduce. Now, you can't avoid that risk completely unless you're willing to just not travel or not drive or anything like that. But you can reduce it by driving safely, conscientiously, not texting while you're in the car, so that you're very unlikely to be at fault if there's any type of accident. You're a defensive driver; that's always should be the first line of attack.

But then, on top of that, if you could retain some of that risk, obviously, and the best way to manage that is to save money, etc., so that if something happens, it's not going to be the end of the world for you financially. What many folks do for that type of risk, and sometimes by law, in fact, many states you have to have liability insurance, and so then you are paying an insurance company to transfer some or a lot of that risk of liability.

It's usually capped to some amount to an insurance company, and I recommend that as well, especially for things like liability. So, once again, just always have that in mind. Okay, where am I? What are my risks? Where can I completely avoid them? Usually, you can't completely avoid them, but you can at least minimize them a little bit or reduce them.

Then, above and beyond that, since those risks are hopefully just going to be reduced, but they're still there, how much do you take on yourself? To manage that, you probably need to have some savings. Or, how much do you transfer to others? That's probably paying someone to ensure that, hey, if that thing happened, that insurance company has got my back to a certain degree.