I know financial disasters may seem like something to prepare for at a more “convenient” time — perhaps once you have paid off your debt or received that promotion at work — but let the financial collapse remind you that you can’t control everything, so you must do your best to plan for anything.
I coach my clients on coming up with game plans in case something goes wrong with their finances. While there's no guarantee you won’t get hurt, preparing in advance means you can absorb the shock and weather the storm much better.
If something does in fact go wrong (the stress, the shock, the fire), how will you react financially? This is a scary question to consider, because the answer might leave you feeling quite vulnerable. Mapping out a “Plan B,” however, will make you feel better and more prepared. Ask yourself, “What is the worst case scenario that could happen to me financially, and how would I respond to it?”
If your income dried up tomorrow, how would you afford to live? I can tell you things like, “A credit card is not emergency savings,” but to be realistic, is that your plan? Would you use a credit card? Would you move in with family? Do you have enough savings to cover you for six, three, or even one month? Do you even know what your monthly living expenses are?
What follows is my personal finance stress test, and it’s nothing like the complicated models many large institutions use. It is just a series of questions to contemplate, and the answers you provide will help you to structure your financial goals and strategies.
What are your must-have/must-pay monthly expenses?
This is food, shelter, transportation, minimum debt payments, health care costs, etc. Write down everything you need to pay to stay alive and maintain your access to quality financial products if needed.
How much of your monthly spending goes toward must-haves versus wants and financial goals?
Go through your budget (or your historical spending, if you don’t have an official budget yet) and determine the percent that goes toward each category. In an ideal budget, must-haves are capped at 50 percent of your monthly income. If you’re over that threshold, consider ways you can get down to that level..
How much do you have in savings?
Not only do you need to consider how much you have available, but you should also make sure you understand how you would you access your savings if you really need it. Research the penalties for taking money out of long-term savings (like retirement accounts), and if potential credit card interest would cost less if you were in a bind.
If your savings is low, do you have access to low-interest credit?
Check your credit score. Is your score high enough to qualify for the lowest interest rate on your card? What about a new credit card with 12 months of interest-free purchases? I am the first one to warn you that a credit card is not emergency savings, but I also know you can’t just wave a wand and stash up your savings overnight.
Are you properly insured?
We have to consider health insurance, life insurance (if you have dependents), disability insurance, homeowner’s/renter’s insurance, and so forth. Make sure you have all the necessary insurance plans set up in the event that you’d need to cash out on them. While you’re at it, check your current credit cards for perks like travel insurance or warranties on purchases.
If you lost 50 percent of your income tomorrow, what would you keep and what would you cut?
This is where the shock starts to set in. What is your spending plan if you only had half of what you are currently bringing in? This is the first tier of what I like to call “shocking your budget,” and it’s not the only one to consider.
If you lost 100 percent of your income tomorrow, what would your monthly spending look like? Filing for unemployment might be an option (if that is the reason for your loss of income). Are there any other gigs you could pick up to bring in some money? What is the absolute bare minimum you could spend to get by?
What is your net worth?
I explain the purpose of tracking your net worth in detail on my blog as an indicator of your growing financial wellness, but this can also illustrate whether your assets can cover your debt in a bind. Also, as you continue to run stress tests on your finances every few months, you can use this as an indicator as to how your financial health is improving.
You may never need the the answers to these questions, but if you do face some bad luck, you’ll be happy you prepared for the worst.
Michelle Bobrow is a member of the DailyWorth Connect program. Read more about the program here.