The Easiest Way to Understand and Manage The Investment Risk
Whatever your investment, you will surely face the risk. So, Let’ s do an analysis to understand and manage this risk is by what we call the Frequency and Severity Matrix (FSM). Frequency represents the possibility of risk which is uncertain. And Severity appoint to the impact if a risk was really happening. Because with this analysis you will be able to behave and act in proportion to the level of risk involved. With just using two sheets of paper you can understand, make decisions and manage your risks both in terms of investment or even aspect -wider aspects of life.
In the first paper sheet, you create horizontal or x axis and the vertical line or y-axis, the horizontal line to represent the frequency of risk while the vertical line to its severity. Or just make a rectangle with length while the high frequency is severity. Then each axis starting from the initial point (0,0) you for three parts and labeled low, medium and high. Square field that is formed will be the place you put the kinds of risks you face. To strengthen the understanding, could you give a color – but left plain paper also does not matter.
Now you just put the kinds of risks you are worried about on the matrix of frequency and severity. Here are some examples.
1. Earthquake: we categorize it has a low frequency (not necessarily happen in a lifetime), but in case of losses, can be catastrophic level or severity of his high.
2. Various forms of a serious accident: its frequency is low enough but the average person never experienced it, the impact is not as high as earthquakes.
3. Robbery: its frequency is lower than the risk of accidents but the impact could be greater.
4. Floods: In some places like Jakarta, flood frequency is between medium high, about five years a big flood. In the event of impact risk can also be fairly large.
5. Theft: fairly common but usually not very big impact.
6. Minor accident: hanging our habits or our daily activities, its frequency can be low to high – but generally low impact.
7. Diseases: This risk includes high enough and its impact-not too serious because sufferers rarely the cause of death.
8. Loss of Value / Purchase Power: Beyond consciousness of many people, the loss of value or purchasing power risk is a statistical near-certainty – that can be faced by anyone at anytime and the impact is very serious. 4.3 Each year we lose half the purchasing power of paper money we have events like the financial crisis and 1997/1998 spend about 75% of the value or purchasing power of money all of us.
Both types of risks as well as its position in the FSM above differ from one individual to another. It’s only natural because it involves a different experience, habits of living, housing, environment etc.. all of which affect the perception of risk.
Risk Identification Matrix
Once we put each of these risks on a matrix of frequency and severity as in the illustration above, the second sheet of paper is paper contekannya more or less like the graphic illustration below.
Risk Management Matrix
By comparing each risk position with contekannya sheet, you are able to decide what will you do about the risks mentioned above.
Risk is high frequency but low severity or impact, then you can hold (retain or absorb) Hopefully it does not matter. While the risk that even if the frequency is low but the impact could be very serious such as an earthquake, then you need to find a solution. Form solution of this second type of risk that are common in the market is insurance.
What about the risks that are relatively common and also quite serious impacts such as flooding?, Wherever possible dijegah (Prevent). These prevention efforts there in the capacity of individuals such as choosing the location of homes / businesses are free to flood, there is also a nature to be done society at large or the government – such as creating water storage reservoirs, flood canals etc..
What about the risks that are in the red zone in the graph above? This is the kind of risks you have to try best to avoid. An example is the risk of inflation or a decline in purchasing power that I put in the red zone, why? Imagine if there is a risk that you take half the treasures every 4.3 years, is not this is a very high risk in terms of its frequency and severity? That’s the reality faced by the inflation of paper money. The solution is to avoid the use of paper money as a means of storing the results of your efforts in the long run because you must lose.
When you move or convert from one type of asset into another asset, automatically change all kinds of risks it faces – that’s why when you do, these risk factors should also be considered. Suppose you switch your long-term savings into property assets; then from paper money at high risk of inflation, you move to a property at risk of floods, earthquakes etc.. But the earthquake and flood risk is lower than inflation, even for earthquakes and floods are still allowed to be protected against through insurance, but there is no insurance t o cover the inflation risk.
Other articles you need to read;
- 3 factors will dominate soon driving the gold price fluctuations.
- Does the Euro exchange rate down drastically affect on the fall in gold prices?
- The Easiest Way to Understand and Manage The Investment Risk
- Which one is your investment choice, investment in shares or gold for the best?
- Where are the trends in gold prices towards the end of 2011?
