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How Risk Tolerant
Are You ?
The risk environment for farmers
is changing. Many factors contribute to today’s especially risky situation.
These include increasing globalization of markets and industrialization of
agriculture; variability of prices and yields; changes in technology; legal and
social concerns; and the human factor itself. Higher risks means that farmers
need new risk management tools.
However, individuals are unique, and so are their personal and financial
circumstances. Farmers need to adopt risk management strategies that are in
accordance with their own risk attitudes, preferences, and business and family
conditions. Understanding how risk tolerant you and your business are can help
you assemble the best combination of tools from the risk management tool bag.
We have all probably made statements like: “If I’d known this was going to
happen, I would have done it differently.” Unfortunately, the consequences of
a decision are not generally known when the decision is made. When evaluating
risky situations, you need to look at:
The probability that an unfavorable event may occur;
The probability of adverse consequences should the unfavorable event occur; and Should the adverse consequences occur, how significant would the disruptions be
to you, your family and the business – how risk tolerant are you?
This will help you evaluate your options and decide which action to take. Taking
no action could also be an option. But it should be a conscious decision you
make after assessing the options, not the result of your lack of knowledge about
the situation.
The following checklists are designed to help you evaluate your own attitudes
toward risk and assess the probabilities of various unfavorable situations.
Answering these questions will help you determine your level of risk tolerance,
in specific areas and overall, which will aid your decision-making in a risky
environment.
Evaluate Your Risk Attitude
Knowledge of your basic attitude towards risk can be helpful in understanding
your feelings in certain situations, and why you make particular decisions.
Which of the following descriptions fits you best?
Risk Avoider - You are a very cautious risk taker. You stay prepared for the
worst, and you dislike taking any chances. Your operation tends to be stable,
but you lose out on opportunities that would involve going out on a limb.
Risk Calculator - You believe that one must take some chances to get ahead.
Before making a decision or taking action, you gather information and analyze
the odds. You try to be realistic, to recognize the risks and them to acceptable
levels. Sometimes you over-analyze.
Risk Adventurer - You feel risks are challenging and exciting, and you often
look for the chance to take risks. You enjoy the excitement of risk taking, and
sometimes you need to be reminded to keep the stakes to a reasonable
level.
Risk Daredevil – You’re a risk daredevil if you take unnecessary chances,
plunging right in (or staying put) with your eyes closed to risk. Although you
might sometimes get lucky, Daredevils commonly fail when they ignore the facts
or refuse to take any precautions.
Your risk attitude influences how you think about risks, but it doesn’t
protect you from risk. In other words, just feeling like a risk adventurer
doesn’t give you any magical mechanism for coping with a bad year. There may
also be other people involved, like family members, who do not share your
feelings about risk. So you need other criteria for choosing your farm’s risk
management strategies.
To take a more detailed risk attitudes quiz, see Purdue University Extension’s
“Risk Attitudes Quiz” at: http://www.ces.purdue.edu/extmedia/EC/EC-647.html
Evaluate Expectations and Probabilities
When determining how risk tolerant you are, it is important to take into account
your expectations about the future of your personal and family situation. In
addition, you should assess the probabilities of various unfavorable
circumstances that would affect prices, costs, yields, and a number of other
factors. However, be cautioned that when evaluating probabilities and
expectations for the future, most people tend to have selective memories. The
recent past tends to be weighted more heavily than events occurring some time
ago. Moreover, if circumstances have changed, the past may provide very little
basis for future expectations. The following sets of questions will help you
determine your overall risk tolerance.
1.
Assess Your Personal and Family Situation
| What
is your age? |
1)
<30 yrs
2) 30-50 yrs 3)
>50 yrs
|
| What
is your health?
|
1)
Excellent 2)
Average 3)
Poor |
| How many people
are you financially responsible for? |
1)
one 2)
two-three 3)
four or more
|
| Do
you expect an event in the near future that will significantly change your
family’s financial situation, such as college, housing, new child, or
retirement? |
1)
Expect less financial pressure
2) Expect minimal change
3) Expect more financial
pressure
|
2. Assess Your
Tolerance to Production Risks
| Yield
variability |
1)
Low 2)
Average 3)
High |
| Probability
of damaging weather during the growing season
|
1)
Low 2)
Average 3)
High |
| Microclimate
or geographic diversification |
1)
High 2)
Average 3)
Low |
| Product
diversification |
1)
High
2) Average
3) Low |
| Production
practices diversification |
1)
High 2)
Average 3)
Low |
| Your
horticultural (or agricultural) production skills |
1)
High 2)
Average 3)
Low |
| Flexibility
to change to different crops and/or production practices |
1)
High 2)
Average 3)
Low |
3.
Assess Your Tolerance to Marketing Risks
| Price
variability |
1)
Low
2) Average
3) High |
| Access
to market information |
1)
High 2)
Average 3)
Low |
| Marketing
diversification (number of marketing channels) |
1)
High
2) Average
3) Low |
| Flexibility
to change marketing practices |
1)
High
2) Average
3) Low |
4. Assess Your
Tolerance to Financial Risks
| Probability
of having sufficient cash from the business to cover operating costs,
personal withdrawals, and principal on term debt each year
|
1)
High 2)
Average 3)
Low
|
| How
is the business growing or developing? (Acquiring assets, making
investments)
|
1)
Gradual
development
2) Rapid development
3) No development
|
| Your
costs of production compared to others in the industry
|
1)
Lower 2)
Average 3)
Higher
|
| Your
farm’s financial health(debt/ equity ratio, cash flow, solvency &
liquidity position) |
1)
Excellent 2)
Average 3) Poor
|
| Level
of your farm’s financial reserves |
1)
High
2) Average
3) Low |
| Family’s
off-farm income |
1)
Significant 2)
Minor 3)
None |
| Personal
or family financial reserves |
1)
High 2)
Average 3)
Low |
| Level
of insurance against business loss |
1)
High
2) Average
3) Low |
| Level
of investment diversification, farm and off-farm investments |
1)
High
2) Average
3) Low |
For a more detailed
financial risk assessment, take the “Business Financial Health and Practices
Test” by Knoblauch, Casler, and Smith, Department of Applied Economics and
Management, Cornell University.
5. Assess Your
Management Skills
| Risk
management knowledge |
1)
High
2) Average
3) Low |
| Farm
business management skills |
1)
High
2) Average
3) Low |
| People
management skills |
1)
High
2) Average
3) Low
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For a more detailed management skills assessment, see Purdue University
Extension’s “Checking Your Farm Business Management Skills” at: http://persephone.agcom.purdue.edu/AgCom/Pubs/ID/ID-237.html
So, How Risk Tolerant Are You?
For each question in the four checklists above, give yourself one point for
every answer (1), two points for every answer (2), and three points for every
answer (3). Add them up. A score of 56 would be right about in the middle of the
pack. The higher your score, the less risk tolerant you are, and the more
attention you should pay to developing risk management strategies to protect
you, your family and your business.
Without a doubt, farm business decision-making is a complex process, and risk
management adds to this complexity. In developing a comprehensive risk
management plan, you need to consider not only the five basic sources of
agricultural risk (production, marketing, financial, legal/environmental, and
people); you need to understand your level of risk tolerance in those areas,
your unique family and personal situation, and your attitudes towards
risk.
Wen-fei Uva and Joanna Green
Department of Applied Economics
and Management, Cornell University
Risk Tolerance Assessment Tools
Risk Attitudes Quiz (Purdue University Extension) In: Decision-Making in a Risky
Environment. http://www.ces.purdue.edu/extmedia/EC/EC-647.html
Business Financial Health and Practices Test (Knoblauch, Casler, and Smith,
Department of Applied Economics and Management, Cornell University)
Checking Your Farm Business Management Skills (Purdue University Extension)
http://persephone.agcom.purdue.edu/AgCom/Pubs/ID/ID-237.html
For more information on risk management,
visit the Risk Management section of Cornell’s Horticultural Business
Management and Marketing web site:
http://aem.cornell.edu/special_programs/hortmgt/risk/
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