Worried about your finances? Know your worst case scenario

Written by Alex

Topics: Budgeting, General Planning, Investing

MoneyMerc is dedicated to “little decisions” that make a big impact.  Our little decision for today is to make sure you know your financial worst case scenario.  These are uncertain times – but the time to plan for the worst case is before you are living it.  Of course everyone’s situation is different, and no one can predict the future… but the goal of this post is to get you thinking about your own situation to prepare you for the unknown.  Don’t get scared – get ready!

A short list of (probably) the worst events for your financial situation:

  1. Losing your job (or spouse’s)
  2. Death of a primary income earner in your family
  3. Parents losing their job or income if they are retired (and start to depend on you)
  4. An unforeseen immediate medical need, either of you, a family member or parent/grandparent
  5. Other large expenses you didn’t plan for (a new child, natural disasters which you don’t have insurance for, etc.)

If any of these occur, in most cases the crux of the situation is cashflow.  Here are some things to consider:

What’s in your personal bailout fund?

Everyone needs a bailout sometime – unlike Wall Street, most people have to work it out for themselves.  Otherwise known as an emergency fund, your personal bailout fund should be easy to access, and 100% safe.  A bank savings account is a great place for this money, because you can walk into your bank on any given day and walk out with the cash.  Other forms of investments like stocks or funds are not good to use (you might be forced to sell when they are down) – ditto for anything that takes more than a day or so to get your money.  If you are lucky enough to have parents or family who can loan you money quickly, that is technically another option for you – IF you can look at yourself in the mirror owing them money.  But don’t relay on that if you haven’t previously discussed the possibility with them, because that wouldn’t count for knowing your worse case scenario.

How big are your bills?

Most people don’t have a full understanding of where their money goes each month.  Bills fall into two categories – those that are essential for living (mortgage payment, basic food expenses) and those that are non-essential but improve living (dinner out, starbucks, new electronics).  Make sure you know exactly what amount of money goes out each month to the essential (“non-discrentionary”) expenses.  It can be an eye-opening experience to divide your emergency fund total balance by your essential expenses.  Ideally this ratio will be 3 to 6 months.  Meaning if you lose your job, you can survive for that long.  With a job market like today, go for 6 months or more if you can.  If your ratio number is less than one, you should start worrying, and then make another little decision to start figuring out how to decrease your expenses.

If you are married and both work, then you should also ask yourselves if you can afford your required expenses on a single income.  Which leads us to…

How secure is your job?

Take step out of your cube, turn around, and look back at your empty desk.  What if you didn’t sit there anymore?  Carefully consider the likelihood of losing your job.  It’s scary to think about, but it’s also easier to work on skills and generally prepare for another job while you have a current source of income.  Think about what industry you work in, and the general stability of other companies in the same industry or of similar size.  Why is your company more secure than others, and why is your job more secure than the person next to you (or than even your boss)?  Is it really?  Keep in mind and try to avoid the human bias which makes us think we are better than we really are (watch the first few episodes of American Idol each season to understand how this works!)  And check out Get Rich Slowly’s 10 Essential Steps to take before you get laid off.

How much debt do you have?

I’m not so worried about mortgages and student loans here – but you should be well aware of how much you owe on your credit cards, and at what rates.  Paying off debt is your financial job #1.  But if you don’t have an emergency fund, it may be wise to start building one before paying off debt. But you definitely don’t want to be in a situation where you can’t afford even your minimum payment.

So what’s the next step?

Now that you’ve thought about your own situation, what is your takeaway?  What one thing can you do to make sure your worst case is a little less worse?  Do you need to get help with your debt?  Or just force yourself to remember to save by setting up an automatic savings plan?  Maybe start talking with your parents about the security of their own financial situation so you can better know how it may affect you?

photo credit – joelogon

2 Comments Comments For This Post I'd Love to Hear Yours!

  1. Chris says:

    Alex, should you consider available credit on credit cards as a stop gap to any short fall you might have in your emergency fund?

    • Alex says:

      @Chris: In general, I’d would say no, since the point of your emergency fund is to keep you afloat for 3-6 months or more. If you are racking up debt during this time, your problem is getting worse and worse, and you are creating a hole that you’ll have to dig out of once you get a job. Keep in mind though, that knowing your worse case scenario also includes taking a real look at your skills and experience, and judging the amount of time it will take you to get a new job. If you have a English Literature degree, it might take you longer to get a job than if you were an engineer with skills to work in pretty much any industry (btw I’m not judging anyone here, I believe all disciplines are valuable in their own way… I’m just challenging you to be frank with yourselves from a finance standpoint).

      One last point, from a behavioral finance point of view: telling yourself you “always have your credit cards” in times get rough might cause you to make excuses not to save. That’s the opposite of the goal of this post. So work to beat your brain at it’s own game. Remember that an emergency fund should be full of assets not liabilities.

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