What Is Accepting Risk?

Jim B.

Accepting risk is a term used in risk management to describe the tactic of allowing some risk that is not too costly to manage. This is done because the cost of avoiding the risk may be too great to justify it when compared to the possibility of the risk being realized. There are many scenarios where the technique of accepting risk may utilized, including investment portfolio construction and project management. Those people managing risk should not simply fall back on this technique out of laziness or frugality.

When accepting risk of an earthquake, a company may manage it by buying affordable disaster insurance.
When accepting risk of an earthquake, a company may manage it by buying affordable disaster insurance.

It is nearly impossible to enter into any new initiative without encountering some sort of risk. A business expanding into a new market runs the risk of spreading its resources too thin. An investor deciding to proceed with buying shares of a nascent company runs the risk that the company will not last long enough to produce positive returns. These are just a few examples where risk management must be practiced with great care. Yet there are times when risk is allowable, so knowing when to deal with accepting risk is crucial in the world of investing and business.

When an entity of some sort decides upon accepting risk, it is doing so because the cost of avoiding the risk may be prohibitive. As a result, taking the risk on is the preferable choice. Some conditions must exist for this to be the case. The risk should ideally be one that is not difficult to manage, or at least one that is unlikely to come to fruition.

For example, imagine that an American company wants to move its operations to the West Coast of the United States, where earthquakes are more prevalent than in other parts of the country. The financial rewards of this move are great because the market in that area is a perfect fit for the business in question. As a result, the rare possibility that an earthquake will wreck the company is not enough to dissuade company management from moving. They are accepting risk, and they can perhaps manage it by finding affordable disaster insurance.

An important distinction must be made between the practice of accepting risk and simply ignoring it. Those people who simply choose to take on a risk because it costs a few more dollars to avoid it might be courting disaster. Decision-makers in the business world must always weigh the risks and rewards of all possible maneuvers and be honest with themselves about the threats posed by certain risks.

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