In risk management, you have to consider the costs and benefits of both the upside and downside possibilities. To understand risk, imagine you are an investor. You can improve the potential outcome of your investments in four ways:
- Reduce likelihood of negative outcomes. Pick safer investments.
- Reduce impact of negative outcomes. Invest smaller amounts.
- Increase likelihood of positive outcomes. Pick investments with the possibility of large gains.
- Increase impact of positive outcomes. Invest greater sums of money.
Picking the Right Risk Management Strategy
It will be obvious that any of these strategies taken to excess is inappropriate. Picking safer investments and funding smaller amounts reduces the chance of positive outcomes as well as negative ones. Stocks, for example, have the potential of big gains but also have uncertainty associated with them, so larger investments increase the potential impact of losses. Balancing upside and downside risk management has elements of both art and science. as you can see, risk manages to play an important consideration in virtually every aspect of business and life. Indeed, virtually every conceivable management activity involves developing and executing risk management strategies.
Figuring out which are the “right” risks and what to do about them isn’t so easy. Fortunately, there is the discipline of risk management. From its origins in the financial and insurance world, the art and science of identifying, analyzing, responding to, and acting on risk has developed into a robust and comprehensive set of constantly evolving tools and techniques that allows for better returns based on investments.