Life is full of uncertainties, and financial life is no exception. Managing risks means taking steps to protect yourself against events or losses that could harm your financial well-being. It’s about creating a safety net so that an unexpected setback doesn’t wipe out years of savings or derail your goals. In the context of financial literacy, managing risk encompasses everything from having insurance, to diversifying investments, to maintaining an emergency fund, to understanding contracts and legal protections in financial deals.
In Kenya, many people have experienced financial shocks – a breadwinner falling ill, a family house burning down, a job loss due to company downsizing, or even positive risks like living very long (outliving your retirement savings). Those who had some risk mitigation (like an insurance cover, or a stash of savings, or multiple income sources) fare much better in such scenarios than those who didn’t. For instance, a family with no health insurance might struggle to pay a big hospital bill and end up selling assets or taking high-interest loans, whereas a family with insurance can have most of the costs covered, preserving their finances.
Risk management might not be as “exciting” as investing or as tangible as budgeting, but it is the defensive strategy that makes sure your offensive moves (like earning, saving, investing) aren’t rendered moot by a single stroke of misfortune. Think of it as installing guardrails and safety belts in your financial journey.
Key areas we’ll discuss in managing risks:
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Insurance: transferring risk to an insurance company for a fee (premium) to cover large unexpected costs (health issues, accidents, property damage, etc.).
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Diversification: the idea of not putting all eggs in one basket, especially in investments, so that the failure of one doesn’t mean failure of all.
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Emergency Fund: we’ve touched on it, but we’ll reiterate as it’s a critical risk management tool against income loss or sudden expenses.
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Legal Safeguards & Contracts: ensuring that when you engage in financial agreements, you are protected by clear terms and knowledge of your rights (for example, proper loan agreements, wills, prenuptial agreements, etc., as applicable).
Kenya has made strides in some areas of risk management (for instance, NHIF offers affordable health coverage, and more people are getting insurance covers), but many still remain vulnerable due to lack of coverage or planning. Culturally, some may rely on the extended family or community to bail them out (through harambees) when disaster strikes. While that communal support is admirable, it’s not guaranteed and can be strained, especially in tough economic times when everyone is pressed. It’s far better to have formal risk management in place.
In the following subsections, we’ll detail how each tool or practice works and why it’s important. The goal is to empower you to put safety nets around your financial life, so that you can take opportunities and even risks (like investing or starting a business) knowing that you’re cushioned if things go wrong.
Glossary
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Risk Tolerance: An investor's ability and willingness to endure fluctuations in the value of their investments without making impulsive decisions.
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Diversification: The strategy of spreading investments across different asset classes or securities to reduce risk exposure.
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Asset Allocation: The distribution of investments among different asset classes, such as stocks, bonds, and cash, to achieve a desired risk-return profile.
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Volatility: The degree of variation of a trading price series over time, indicating the level of risk associated with an investment.
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Beta: A measure of a security's risk in relation to the market, helping investors assess the asset's sensitivity to market movements.
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Standard Deviation: A statistical measure of the dispersion of returns for a given security or market index, indicating the level of risk.
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Risk Premium: The potential return on an investment in excess of the risk-free rate, compensating investors for taking on additional risk.
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Sharpe Ratio: A measure of the risk-adjusted performance of an investment, considering both the return and the volatility.
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Hedging: A strategy to reduce risk by taking offsetting positions that will minimize potential losses.
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Liquidity Risk: The risk associated with the ease of buying or selling an investment without causing a significant change in its price.
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Credit Risk: The risk that the issuer of a bond or other debt security may default on interest or principal payments.
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Market Risk: The risk that the entire market, or a particular segment of it, will decline in value.
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Systemic Risk: The risk that events outside an individual's control, such as economic downturns or financial crises, will impact the entire market.
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Country Risk: The risk associated with investing in a particular country, including political instability, economic conditions, and regulatory changes.
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Leverage: The use of borrowed funds to amplify potential returns, but also increasing the potential for larger losses.
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Downside Risk: The potential loss an investor might incur if the value of an investment decreases.
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Value at Risk (VaR): A statistical measure of the maximum potential loss of an investment portfolio within a specified confidence interval.
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Tail Risk: The risk of extreme and unexpected events that deviate significantly from the normal distribution of returns.
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Counterparty Risk: The risk that the party on the other side of a financial transaction may default on its obligations.
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Mitigation: The process of reducing the severity or impact of potential risks through various risk management strategies.