Preparing for an unanticipated and unforeseen financial disaster may seem like an oxymoron. How can you possibly prepare for something that is unknown?
You can, as long as you remember that the only thing really “unknown” about most potential financial calamities is their timing. We know perfectly well we’re likely to have emergencies; we just don’t know exactly what or when. They may take the form of expensive car repairs, trips to the emergency room, the loss of a job, or a significant investment loss. The question really isn’t “if;” it’s “when.”
Here are four tips on preparing for the inevitability of a financial calamity.
1. Get out of debt, now. Since most financial disasters have a lack of cash flow at their core, existing debt payments will only multiply your financial distress. The double whammy of a financial catastrophe is not being able to make your debt payments and adding the trauma of a home foreclosure, a vehicle repossession, or ruining your credit rating when you can least afford to. In addition, one option in a financial calamity is borrowing the needed funds to get you through to the other side. If you are already heavily in debt going into the crisis, it’s highly unlikely you can borrow more just at the time you may really need to.
2. Build an emergency reserve and leave it alone. Based on the high unemployment of the last three years, I shouldn’t have to build a case for having six to 12 months of household expenses in a reserve account. No matter how secure you think your job is or how much you hate having money sitting in a money market account earning next to nothing, you need an emergency reserve. This is not an investment, it is insurance against inevitable financial calamities. Also, never raid your emergency reserve for unplanned lifestyle expenses. Vacations, Christmas, taxes, and new vehicles are not emergencies. You need a separate savings account for these anticipated expenses.
3. Insure yourself against the unknown. Insurance is one of the most efficient tools you can use to protect yourself from financial calamity. Adequate auto, renters or homeowners insurance is always a must. If you have young children you need a minimum of $500,000 of life insurance on both working and stay-at-home parents. Younger people also have a greater chance of becoming disabled than dying, so adequate long term disability covering two to three years of income is important. Having the right insurance is important as well. I don’t recommend cancer, flight, or credit life insurance. They are expensive and largely unneeded if you have your base insurance needs covered.
4. Diversify your investments among asset classes. The best insurance you can have against inevitable economic plunges is to own some of what’s going down and some of what is inevitably going up. While getting out of the market prior to a downturn and buying back in at the bottom sounds logical, believing you can execute that strategy is insane. Diversification doesn’t just mean owning different types of stock funds or buying from different investment brokers, either. It means having lots of asset classes in your portfolio like global stocks and bonds, real estate, commodities, TIPs bonds, and alternative investments. The easiest way start building a diversified portfolio is to find a diversified mutual fund that will do this for you. A couple of examples are First Eagle Global and American Capital Income Builder.
Protecting yourself with these four strategies can ease your fears about what financial calamities might happen. You’ll know that whenever they do, you will be prepared.
