While you can’t plan for every unexpected financial emergency, it’s reassuring to have a contingency plan to overcome or minimize any financial uncertainty that may come your way. The Covid-19 pandemic has proved how important it is to prepare for unexpected events. A little planning (and saving) in advance will make those unanticipated emergencies much easier to handle. Here seven ways in which you can prepare yourself for the unexpected.
1. Budgeting & Debt
Budgeting is one of the easiest things you can do to improve your financial security. A budget will reveal what’s coming in, how much is going out, along with a few surprises (hmm, I didn’t know I spend so much at Wawa!). You can use pen and paper, a spreadsheet, a mobile app, or your bank’s software.
I even suggest taking budgeting one step further. I’d create a secondary “Emergency Budget.” Yeah, I know, you don’t even want to do a regular budget, but stay with me. Suppose you have to endure a long period of unemployment or loss of income – a severe financial emergency. In that case, you should know the necessities vs. the items you could do without. Having that emergency budget in your back pocket will make an already stressful time more manageable.
Part of budgeting is controlling debt. Track how much you have and the amount of your income that is going towards debt. Of course, we all know carrying balances on credit cards with high-interest rates is not wise. When the unexpected happens, it’s downright debilitating to your long-term financial health.
Do yourself a favor and eliminate credit card debt and keep your mortgage and auto loan debt levels to under 15% to 20% of your income. For example, if you make $100,000 per year, keeping your debt payments under $15,000 to $20,000 per year should be your target.
2. Have an Emergency Fund
Once you have your budget in place, it’s easy to determine how much you need to have in your emergency fund. Your emergency fund should contain anywhere from 3 to 12 months of living expenses. This depends if you’re single, married, two-income, or a one-income household.
An emergency fund can get you through both the usual unexpected car and home repairs and the longer-term medical emergency or job loss. Keep a few months of cash in a savings account and stash the rest away in a money market account.
3. Plan for Natural & Unnatural Disasters
Think about your surroundings. Is there potential for tornados, hurricanes, floods, wildfires, or earthquakes? If so, you need to be prepared to deal with them:
- Make sure your insurance coverage protects you from the possibilities.
- Always have an emergency kit ready with a five-day (or more) supply of food, water, and cash.
- Always have your essential documents in a secure location, in a bank safe deposit box.
A new type of disaster also must now be planned for. So much of our lives are online and networked, we are susceptible to hacking. I don’t think it’s out of the realm of possibility to lose access to banking card systems sometime in the future. I’m not recommending you begin building the bunker. Still, it is prudent to keep cash on hand, secure in your lockbox or safe, if you lose access to your banking network for an extended period.
4. Have the Proper Insurance Coverage
Insurance protects you from unexpected financial emergencies. Life, health, home/renters, auto, and disability – They all have a purpose and cover various emergency situations.
Life: You should have enough life insurance to provide for your family. The policy’s death benefit should be enough for your beneficiary to replace a portion of your lost income and pay off debts after you pass away. If you have children, the policy should also cover the cost of their education.
Health: It only takes one serious illness or accident, then you could find yourself deeply in debt. If you do not have employer-provided coverage, it’s vital to obtain a stand-alone or marketplace policy.
Home and Auto: Accidents and unforeseen damages happen. Ensure you have enough coverage to cover all of your potential costs resulting from an unexpected event. If you’re a renter, don’t forget about renters insurance.
Disability: If you are injured to the point you can no longer work, disability insurance may bridge the income gap. These policies typically cover 60% of your income, and that’s better than nothing!
5. Save for Retirement
Why would saving for retirement be one of the recommendations for preparing for an unexpected financial emergency? Think about how many times you’ve heard of people in their late fifties or early sixties losing their jobs and not being able to find another one.
Sometimes retirement isn’t your choice. Start saving early and save as much as possible in your retirement plan. Work it into your budget! Retirement may arrive sooner than you think.
6. Manage Retirement Cash flow
The unexpected happens in retirement as well. Recessions, bear markets, and unexpected financial emergencies will occur in retirement. Multiple times. Accept that fact and prepare for it. Have a retirement distribution strategy in place.
Managing your investment portfolio based on your risk tolerance and capacity is imperative. It requires walking a fine line of achieving a return that will outpace inflation and provide enough income for retirement versus being too aggressive, resulting in a significant loss. It’s not just about how much your comfortable taking. It’s also about how much risk you can afford to take.
When you are drawing from your retirement accounts, a loss of 40% (2008) could be catastrophic for your retirement success. You may not have the ability or time to wait for the market to recover.
What should you do?
- Have enough cash to cover expenses and emergencies in the short term, say a year or two.
- Have a well-diversified portfolio with a mixture of conservative investments for 2 to five years.
- Look at the long-term: Don’t be rash or panic during periods of downturns. Don’t focus on the short-term. Instead, look at the longer-term goals.
7. Estate Planning Documents
There are a few essential items you have out to protect your estate from the worst kind of financial emergency – your death!
- Beneficiaries: Make sure you have the appropriate beneficiary for all retirement accounts. Spouse primary, children contingent.
- Last will and testament: Having a will is vital if you want to pass assets to heirs or charities. You can also spell out funeral arrangements. Once you have a will in place, make sure you update it every five years, or when you have a significant life change,
- Durable Health Care Power of Attorney: This allows a person to make all major and minor Health Care decisions for their loved one. It doesn’t prevent a person from making their own decisions but does allow the POA to make decisions if necessary. At the very least, as the POA, that person has the authority to talk to everyone about their loved one’s healthcare. I suggest making two or three original documents.
- Durable Financial Power of Attorney: This gives the power to act as if they are that person in all financial situations. The person can buy, sell, transfer, pay, not pay and deal with any asset. Checks and balances are required in the document. One note, make sure your bank will recognize your power of attorney. Sometimes they need their own forms.
- A living will: Also called an advanced medical directive, this document outlines your wishes should you need to be resuscitated.
You should have these items, regardless of your age or wealth. Also, please make sure people know where the documents are located. It really helps your heirs during an already difficult time.
Completing these seven tasks, which really aren’t that difficult, will give you peace of mind. You’ll have created your very own financial emergency contingency plan that will reduce the risk and worry of uncertainty.
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