Risk management may now be ready for prime time | Chet Currier

That is why we need minimax!

Working with "incomplete knowledge, a central bank needs to consider not only the most likely future path for the economy but also the distribution of possible outcomes about that path" - Alan Greenspan

In his first speech of the new year, Alan Greenspan came as close as he ever does to dispensing investment advice.

The Federal Reserve chairman told the American Economic Association that policy-making at the central bank had come increasingly to be guided by what he called "risk management".

The term, well known to actuaries and institutional money managers, is less familiar to everyday people as they make financial plans and decisions. With a push from Mr Greenspan, maybe it is now ready for prime time.

That would be good, because risk management can be the basis of a realistic approach to personal finance - a much-to-be-preferred alternative to idle games such as guess-the-future or beat-the-market.

Buying an insurance policy is risk management in one of its simplest forms. For a fee known as the premium, an insurance company assumes a risk that naturally occurs in your life, such as the chance of a house fire or a lawsuit.

In a broader sense, all investing can be seen as risk management, in its goals and its methods. Just as a life insurance policy hedges the risk of dying too soon, before important obligations are met, so its opposite number, an annuity, protects against the risk of dying too late, after one's money has run out.

One thing to love about risk management is its basic humility. Where many amateur investors try to show the world how smart they are, the risk manager admits the future is a mystery.

The variables include risks, which can at least be estimated, and uncertainty, where even the probabilities are hidden. "It may be best to think of a continuum ranging from well-defined risks to the truly unknown," Mr Greenspan said.

Kitchen-table financial decisions can then be based on a careful assessment of what these risks and uncertainties are for the individual or family in question.

Got two children between five and 10 years old? There is an odds-on chance both will want to go to high-prestige universities about a decade from now - and an equally strong likelihood that the fees will be twice that charged today.

Getting close to retirement age? Ahead lies a range of risks and uncertainties from the chance of near-term health problems to the possibility you may have 30 or 40 years of life left to pay for.

How to allocate one's assets to meet the defined needs and goals? That decision uses risk-management thinking, too.

From experience we know that stock returns are highly variable and unpredictable from one year to the next. Over longer periods of time, the odds mount in favour of decent or better returns.

No matter how much time you have, though, the stock market carries a certain amount of uncertainty. One may hope, even believe, that the next 50 years will bring economic growth comparable to the past 50 years. All the same, one cannot count on that, or expect to quantify all the possibilities that can stop it from happening.

So even a young person with distant goals may consider diversifying an investment plan to allow for surprises.

As any insurance buyer knows, it is impracticable to protect against every imaginable risk. While some may stash away gold and canned goods in case of a catastrophe, others may conclude the end of the civilised world is a hazard that cannot usefully be hedged.

Also, some circumstances may call for abandoning caution. A once-in-a-lifetime chance to start a business of your own, for instance, may dictate staking everything you have on it.

When you think about it, even that kind of choice really comes down to risk-based decision-making. The best candidates for bets of this type are people who know they can pick up and start again if the venture does not pay off.

Working with "incomplete knowledge, a central bank needs to consider not only the most likely future path for the economy but also the distribution of possible outcomes about that path", Mr Greenspan said. It is a worthy starting point for non-central bankers, too.