I’ve only been alive for 18 years, and I’ve already survived quite a few “end of the world” predictions. Y2K, 06/06/06, and half a dozen predictions by Harold Camping. And only a couple of days ago, we passed the last days of the Mayan calendar, which supposedly meant an apocalypse was coming. Obviously none of these predictions have come true, and I rather doubt that any will in the near future. However, there are some disasters that may just happen to you at some point in your lifetime, and it is wise to always be prepared for them.
This is the first post in a multi-part series I’m writing about preparing for emergency situations. While I would love to one day write about preparing for things like the zombie apocalypse, I’ve decided to start with writing about how to deal with financial emergencies. Many of us will at some point experience a job loss, a medical emergency, a business failure, or some sort of other costly circumstance that comes out of the blue. I’m going to cover how to prepare for a few of these micro, or personal, level situations. The best method for handling them is going to vary widely based on the details of your predicament as well as your personal and financial situation. But there are some general tips I can give you that will help, and maybe make your situation a little easier to cope with.
Building an Emergency Fund
First and foremost, everyone needs an emergency fund. The size and other details of such a fund are highly debated by financial experts worldwide, but nearly all of them agree that you need some sort of highly liquid fund that you can access if needed.
In my opinion, you should have enough money in a savings account to cover between two and six months worth of expenses at your current spending rate. The reason I have such a big gap is because every person’s or family’s situation is totally different. Here are the main factors that will help you determine how large your fund should be:
- How high is your networth? If you have a lot of investments set aside in various places, your emergency fund will not need to be very large at all. If you lose your job, you can always sell some of your assets to keep up with your expenses.
- How likely are you to lose your job, and can you find another one if you do? Be honest with yourself when thinking about this one. If you are a valuable employee at a large company, then job loss isn’t likely, so you won’t need as much of an emergency fund. If you are a low level employee at a private company that gets mediocre performance reviews, you should have a much larger fund.
- Do you have any debt? Many expenses can be minimized if times get tough. Cutting your spending down to a fraction of its former self in order to survive is very possible for most people these days. But if you have debt, those payments will stay the same each month. Your creditors aren’t going to feel bad for you if you lose your job.
Let’s look at a couple of example people who are realizing they need an emergency fund.
Person A has a family and a steady job at a large bank. He has done well in the past, and has half a million dollars in assets, mostly in the stock market and equity in his home. His only debt is his mortgage. He has a solid education and lots of work experience in high level positions. With that kind of setup many would think he doesn’t need an emergency fund. However, I still think he does. You never know when your car will blow up or your company will decide to fire you, and you can never be too careful. Two months worth of funds is what I would recommend for this person.
Person B is a little bit worse off. Not so bad that he could never feasibly cobble together an emergency fund at all, but he certainly isn’t wealthy. He also has a family, but his job is a low level job at a startup technology company. He owns a home with a mortgage and has a retirement fund with about $50,000 in it, as well as a few thousand in various other accounts and investments. He has gotten rid of most his debt before starting to save an emergency fund, which was a wise move on his part. He still has a fairly expensive mortgage though. For Person B, I would recommend a fund which could cover five to six months months of expenses, the top of the scale. His job is a little bit sketchy because of the volatile nature of startups. He also has a higher debt payment to income ratio, so losing his income altogether would make it hard to keep up with payments.
If you take into account those various things I talked about, you should be able to quickly figure out how large your emergency fund should be based on your current spending. Once you figure out how much you need, start putting that money you should have left over at the end of each month into a savings account. There are other options for your emergency fund, but I like savings accounts because they can be accessed easily anytime, anywhere. Some people recommend laddering short term CDs for your emergency fund, but I highly discourage that. If a true emergency happens, how likely is it that it happens right when your CD matures?
Building up an emergency fund isn’t the only way you can prepare for job loss. In fact, you can minimize your need for one if you do a couple other things:
- Get ready to get Re-Employed: I’m pretty passionate about the fact that anyone can get a job if they put in some effort. In fact, I wrote a whole ebook about it. If you sign up for my newsletter you can get free access to “Get a Job NOW!”. This short ebook shows the strategies I’ve used that have made it possible for me to never get turned down for a job.
- Build a side income: Building up a side income is actually much easier than you’d think. Whether it is online, freelancing, owning rental homes, or any other type of side job, having that extra income may just allow you to survive a financial emergency.
As I’ve mentioned before, health care is a very expensive part of life in the United States. Preparing to cover the cost of a medical emergency is something that you simply can’t do alone. If you or a family member is involved in a car crash and have to be life flighted and given a variety of surgeries, the bill can literally be hundreds of thousands of dollars. I’ve had several close friends that have had such emergencies. I personally broke my face (yes that is possible, and no it wasn’t pretty) playing basketball a few years back. I went to the emergency room and got a simple cat scan and a few other tests, and the after only an hour and no treatment whatsoever, the bill was literally several thousand dollars.
Thankfully, health insurance was designed to minimize those costs. If you work a job with benefits, you likely already have health coverage that will cover any sort of medical emergency expenses. It not, you should consider getting emergency medical expense coverage. These are relatively inexpensive health insurance plans with a very high deductible, typically around $10,000. If you keep your body in good shape and maintain good health habits, then your routine health expenses are going to be significantly lower than the average American’s. So you likely don’t need to have fancy coverage with all sorts of perks and a low deductible. But having that emergency coverage will allow you to be protected from the enormous bills associated with a major medical emergency.
Entrepreneurs are the lifeblood of our economy. And if you’ve read about the Life Rich lifestyle, you know that entrepreneurism is something I strongly advocate. However, studies have shown time and time again that a vast majority of all business fail within a few short years. So with the odds against you, how can you make sure that you survive if your business collapses?
In many ways, the strategies for preparing an emergency plan for a business failure are similar to that of a job loss emergency plan. Make sure you have enough of an emergency fund to cover several months worth of expenses at the least. Also, continue to build your resume and network, that way you can find a job if your business fails.
When it comes to the actual business, I’ve found that following a simple one sentence rule allows you to prepare for the worst. Build your business so that you are personally responsible for as little as possible of it.
Now that may sound odd, seeing as a business should be very personal and attached to the person who owns it. But if your business tanks and you are fully personally responsible, you will run into some major uphill battles. I plan on writing a full post about this in the future, but for now, here are some of my top tips:
- Setup your business as an LLC. A Limited Liability Company is a type of business entity that can be easily filed in any state. It does what its name suggests, it limits liability. My freelance web design business is legally filed as an LLC. If someone wants to sue the business, they can come after what the business owns, but not my personal assets.
- If you have to take a loan, try not to tie yourself to it. Business owners often times take on a huge amount of debt to get their company off the ground. Do everything you can to make sure that your business loans are tied solely to the business, and not to you personally. This isn’t always possible, but make it happen if you can.
- Clearly distinguish what the business owns and what is yours. If you follow my advice from above, it is very important that what the business owns and what you own are clearly separated, at the very least on paper. That way you can prove what your personal assets are if the worst happens.
If you follow all of the above tips, making sure to adapt them to your own personal situation, you will be ready for the most common micro financial disasters. Stay tuned for the next part of this series, in which I’ll tackle the more challenging and sometimes important macro financial issues, like dealing with an economic recession.