Independent, Fee-Only Financial Advisor

Independent, Fee-Only Financial Advisor

Friday, February 19, 2021

On Preparedness

In every meeting we ask something along the lines of "do you have emergency savings?" The answer is different for everyone, as an emergency looks different to every client. Recently, those definitions have blown up again and again for many of us.

We did NOT see this coming!

One emergency came in March of 2020, when states, cities and businesses themselves closed down or severely restricted service, the economy contracted harshly. Many people found themselves out of income while we waited for customers to be able to return safely. For so long, we have viewed emergencies as a sudden need for cash - replacing a wrecked car, covering sudden medical bills or moving your family across the country. This emergency was one of a drastically reduced income.

Over and over again, I found myself in conversations with clients talking about how this crisis highlighted the unpredictable nature of emergencies, and how broad the task of preparing financially for an emergency is.

Loss of income is an emergency that we can prepare for. The classic advice is to have 3-6 months of your income safely saved away in cash. What we have seen recently is that this advice is not enough. We are nearly a year into this period of high unemployment. If you had three months of income saved and gritted your teeth in March, you would be out of money by June. If simply saving up won't protect you from losing your income, what can you do?

To survive a loss of income, you need savings, a strong community and a resilient budget. A resilient budget is one that can quickly adjust to a new income level. A resilient budget has low fixed expenses and high savings rate. If you are saving 5% of your income, then you are spending, and will need to replace, up to 95% of your income in an emergency. If you are saving 25% of your income, you will only need to replace up to 75%. Importantly, at a savings rate of 5%, it will take 19 months to save a month's worth of expenses, while a 25% savings rate can replace a month's worth of expenses with only three months of saving.

I generally view fixed expenses as things like housing, car and consumer debt payments, utilities and a basic level of groceries and gas. Many of these expenses are locked in for months or years to come with no real opportunity to change. If much of your spending can be cut out in any given month, your budget is flexible and resilient to loss of income.

More recently, snow and ice have blanketed much of the south - a region wholly unprepared for cold weather lasting more than a day. A perfect storm of precipitation and below freezing temperatures froze roads, keeping goods from reaching stores, and customers from getting what they needed. In Texas, oil wells and gas pipelines froze cutting off a vital supply of energy and electricity across the state.

This temporary crisis won't change paychecks for long, but it emphasizes non-monetary preparedness that people can take. Having neighbors that you can rely on for a meal when your power is out, or help clearing ice from your walkway is more important today than the dollars in your savings account. While there will be financial emergencies as people push their heaters to the limits, or slide off the road on the way to the grocery store, our immediate needs will be met with out own preparedness and deep networks.

After crises, many people reflect back on the people that helped them through. This is one of those times.

Over the years I have developed a framework for thinking about emergencies, but no matter how much you prepare, the unexpected can still happen. For the foreseeable emergencies, you need to identify big risks in your own life: aging parents, an old vehicle, a medical risk, or an income that may disappear. Each of these has a cost that can be calculated and set aside for. Setting aside money for regular expenses is important too, and a resilient budget will help there. Lastly, knowing where you will get non-financial resources can help in the most unexpected of crises. Knowing who you can rely on for help when the worst happens will be how you fulfill your immediate needs and stay financially solvent in the long term.