Nobody likes thinking about the worst-case scenario. Mass layoffs at work, a broken pipe that floods the house, or sudden death in the family are so many ways our lives can change instantly. But just because they’re hard to think about doesn’t mean you shouldn’t consider the possibility of an unexpected event. You owe it to your financial wellness to prepare for the “what ifs” in life.
Being financially prepared for an unexpected event is the difference between draining your 401(k) to cover emergency expenses (never a good idea if you can avoid it) and having the peace of mind that you’re financially prepared to handle whatever comes your way. Below are our top five strategies for being financially prepared for a sudden (and costly) unexpected expense.
Build an Emergency Fund
You’ve probably heard of an emergency fund before, maybe you’ve heard it called a “rainy day” fund. Essentially, an emergency fund is a separate savings account you rarely touch unless (you guessed it) you experience a financial emergency. What counts as an emergency is up to you, but it might be a sudden job loss, major home repair, unexpected medical bill, car repair, you name it.
Every household needs an emergency fund, though the exact size of your savings will depend on your unique situation. The general rule of thumb is to have between three and six months of income in an emergency fund. For example, if you earn $100,000 a year, your emergency fund should ideally have somewhere between $25,000 and $50,000 in it.
That sounds like a lot of savings, but it’s essential to have enough set aside if you cannot work for an extended period. Growing your emergency fund won’t happen overnight, but there are a few simple ways to start saving:
Budgeting: If you haven’t already, consider creating a monthly budget. Instead of putting whatever’s left over at the end of the month into your emergency fund, prioritize paying yourself first. Budget out your bills and recurring expenses, then set aside a certain amount for your emergency fund. Even if it’s a small amount, getting into the habit of contributing regularly will help build your savings over time.
Automate Savings: Most banks and financial institutions will allow account holders to create automatic transfers between accounts. Once you create a dedicated savings account for your emergency fund, let your bank know you’d like to automatically transfer a certain amount each month from your regular checking account into the emergency fund. Taking a “set it and forget it” approach is the most effective way to grow your savings without lifting a finger.
Supplement Your Income: We’re officially in the golden age of side hustles, and it’s easy to see why. Inflation has wreaked havoc on our wallets, student loan debt is squeezing our budgets, and home prices keep rising. A recent survey found that 50% of millennials have side hustles, which earn an average of an extra $810 per month.1 If you’re finding it hard to make ends meet and grow your emergency fund, a temporary side hustle could boost your budget. This is a great way to grow your emergency savings quickly!
Review Insurance Coverage
One of the most effective ways to financially prepare for the unexpected is to incorporate the right insurance coverage into your financial plan. While there are a ton of different types of insurance policies available, the core four every millennial should have to include:
- Health insurance
- Homeowner’s (or renter’s) insurance
- Auto insurance
- Life insurance (if you have someone who depends on your income)
Many factors go into choosing the right policy type for you and your family. It can be overwhelming to review all your options alone, so we can help you work through this, especially as it relates to the rest of your financial plan.
As you assess your insurance needs to choose the right type of coverage, here are a few considerations to make:
- Evaluate risks and vulnerabilities: It’s impossible to predict the future (unless you have a crystal ball), but assessing your current risks and potential vulnerabilities is possible. For example, obtaining a more robust health insurance policy could be a wise choice if you have a family history of early-in-life health concerns. Or, if you have a child on the way, obtaining a 20-year term life insurance policy would help ensure your growing family is covered if something happens to you.
- Researching and comparing: Not all insurance policies or providers are created equal. You will need to compare policies side-by-side to understand what’s covered, what’s not, what may be out-of-pocket (deductibles), and how much you’ll have to pay per month (premiums). As you review your options, be sure to compare these policies against your “wish list” to find ones that best suit your budget and coverage needs.
Establish a Financial Safety Net
While an emergency budget and insurance policies give you the resources to react better to unexpected financial turmoil, there are a few ways in which you can work proactively to avoid it in the first place.
Diversify Income Sources
You’ve likely heard the adage regarding investments, “Don’t put all your eggs in one basket.” Diversifying your holdings reduces risk by spreading it out amongst multiple assets. Say all of your investments were in one specific stock , and without notice, they shut their doors tomorrow. You’d lose your entire portfolio. But if you have other investments padding your portfolio, the blow from this stock is cushioned. This is why I encourage my clients to invest in index funds and ETFs rather than individual stock holdings.
Well, the same goes for your income. Relying on one employer who pays you for one particular skill set is riskier than people realize. Work with your financial advisor to find ways to create multiple streams of income (this could include the side hustle we mentioned earlier) in addition to a diversified investment portfolio. Having another source of money flowing in, such as dividends or rental income, can reduce the financial impact of a sudden job loss.
Create a Debt Management Plan
The less debt on your plate, the fewer recurring financial obligations you have to tend to each month. Make debt repayment a priority for your budget to free up your future cash flow. Explore debt consolidation or refinancing options, as these options help reduce the amount of interest that accrues on your debt.
There are different strategies for tackling debt, but consider starting with paying off any unsecured debt with the highest interest rate first. Unsecured debt, like personal loans or credit cards, tends to have the highest interest rates.
Establish a Line of Credit
A line of credit is a helpful tool to have in your back pocket. By now applying for a line of credit, you’ll have access to funds if you need them quickly. If you own property, a home equity line of credit is based on your home’s equity and can offer a lower interest rate than a credit card. You may be able to get an intro rate for 6-12 months at a fixed percentage and then the rates are variable after that. You can also open a personal line of credit, though the rates may be higher because unsecured lines of credit are riskier for lenders.
Focus on Long-Term Financial Planning
While we’ve been focusing on how to prepare for the unexpected, it’s worth mentioning the “expected” as well. Long-term financial planning is critical because it balances your obligations today with your goals for the future, such as retirement. When you’re doing what you can to prepare for the future, managing unexpected financial needs without sacrificing your long-term goals is much easier.
Continue contributing to your retirement savings accounts, like an IRA and 401(k). If you haven’t started building a retirement savings plan yet, we can help you determine how much you’ll need to retire comfortably and what we can do together to get you there.
You likely have other goals as well, and we can work together to build you a diversified investment portfolio that reflects those goals and your unique tolerance for risk.
Reassess and Update Your Financial Plans Regularly
Just like going to the doctor, having regular check-ins with a professional is a good idea to assess your current financial health. Your life is dynamic and ever-evolving, and that means a financial plan you developed five years ago may no longer work for your needs and goals today.
As you move through life stages and experience new circumstances (like getting married, starting a family, or changing careers), adjust your financial plan to ensure it always reflects your current needs.
Enjoy the Peace of Mind Being Prepared Brings
Being financially prepared brings about an incredible amount of peace of mind. While facing an unexpected financial emergency is never fun, having the resources to address it without sacrificing your other financial goals is a huge step toward financial independence.
Many of the steps above can be done independently, but you may find it helpful to speak with a financial advisor first. Saving for retirement, for example, is something you only get one shot at and can be overwhelming to try and tackle alone. If you want to discuss any of the tips found here, feel free to contact us. We’d be more than happy to review your current standings and help address any areas of concern you may have.