Before you invest your hard-earned money in any business venture, you must evaluate the risk involved and how much risk you can handle. This process is called Risk Assessment.
Risk assessment refers to the process of analyzing and determining the probability of loss in a venture. This determines whether or not an investment is profitable in the long run. It helps you identify potential hazards and prepare methods for minimizing loss.
The risk assessment is performed by a skilled person who fully understands how the investment works. Before any risk is taken, you must consider your risk profile. The risk profile shows the willingness and extent to which you can take risks. It determines what assets can be allotted to your investment portfolio.
The process of assessing and managing the risk generally involves 5 steps:
● Identification of potential hazards: you must first identify the possible risks involved in the investment. Consult experts in the field and find out possible risks. Make use of investment risk assessment templates to help you rule out every possible hazard.
● Analysis and measurement of investment risks: after identifying potential risks, you should analyze them to know which is higher. This can be done quantitatively or qualitatively. Quantitative analysis involves models that demonstrate risks using numerical values. Qualitative analysis takes a subjective approach, and the investor uses their experiences to analyze the risks.
Standard deviation, Beta, Sharpe ratio, R squared, Value at Risk (VaR), and Conditional Value at Risk (CVaR) are other methods used to measure risks.
Standard deviation is one of the commonest methods of assessing risks in investment. The standard deviation highlights the profitability of an asset. It considers the historical trends of your investment and the possible outcomes.
● Formulation of methods for risk management: this is where you formulate methods to manage the identified risk. It is a plan that ensures you mitigate risk and maximize profits. A case study shows that risk management was key in the decision-making process of an investment project and optimized risk in relation to profit. This shows that risk management plays an important role in investment.
Common methods for managing risks are:
○ Transfer of risk: this is to turn over the risk to a third party
○ Reduction of risk: this is to diminish losses that may arise from the risk
○ Retention of risk: this is to take on the risk and accept corresponding risks
○ Avoiding risk: this is to eliminate any factor that facilitates risk
In choosing a suitable risk management method, you should evaluate and understand the nature of the risk. If it is a high-risk investment that you are not equipped to handle, you may want to transfer or avoid it.
● Execution of risk management methods: the next step is executing the risk management method of your choosing. It involves carrying out the necessary steps in the method you have chosen to reduce possible losses associated with your investment.
● Monitor the risk management method you have implemented: the work in managing investment risks does not end with the implementation of methods. Ensure that the risk management methods are complied with and make necessary adjustments to suit any change. Routine monitoring will help you see if the risk management method is working effectively.
REFERENCES:
https://www.investopedia.com/terms/s/standarddeviation.asp
https://www.researchgate.net/publication/283170627
https://csrc.nist.gov/glossary/term/risk_profile
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