What is meant by risk management in financial planning?

Risk management in financial planning refers to the process of identifying potential risks that can impact an individual's or a family's financial health and taking steps to mitigate or manage those risks effectively. This is crucial because financial stability is affected by various unpredictable factors, such as market volatility, unexpected expenses, changes in income, and even external economic conditions.

By identifying risks—such as the possibility of job loss, health care costs, or investment losses—and implementing strategies to manage them, individuals can better protect their financial resources and achieve their financial goals. Risk management can involve diversification of investments to reduce exposure to market fluctuations, maintaining adequate insurance coverage, and having an emergency fund to cover unforeseen expenses.

The other choices relate to financial strategies but do not effectively encapsulate the concept of risk management. Investing only in high-yield stocks may increase potential returns, but it does not consider the risks involved. Cutting all expenses might also seem like a way to reach financial goals, but it disregards the balance needed for a sustainable lifestyle and financial health. Finally, avoiding all types of investments is not a practical approach to financial planning, as it eliminates opportunities for growth and wealth accumulation while also ignoring the importance of managing investment risk.