I receive many emails each day from people who have had some kind of financial crisis. Most of these stories have a great many factors in common with each other, although the specifics can vary wildly. Here are some of the specific elements many of the stories share.
Something unexpected happened. Life was going along seemingly well until something happened. A job loss. An illness. A pay cut. A credit card cancellation. A car failure. Something triggers a big financial downturn.
You were operating without some type of financial safety net. The person in question often isn’t prepared for this unexpected financial downturn. They don’t have the resources on hand to deal with it.
Things you thought you could rely on weren’t as reliable as you expected them to be. The person doesn’t have credit available that they expected. Friends and family they believed would help them out didn’t come through. The landlord wasn’t as forgiving as they expected he would be.
You didn’t respond in the best way when the crisis first happened. Your first response to the crisis was often to either stick your head in the sand or to make another immediate financial mistake, such as putting the car repair bill on a credit card. Often, there are a sequence of small errors following the unexpected event.
The situation now seems unescapable. You’ve gone from where you were at before the unexpected event to a situation that now seems unescapable.
For me, the unexpected event was Sarah getting pregnant. The immediate bad move we made was to spend way too much money preparing for the baby.
Obviously, if I could roll the clock back to 2004, I’d do everything I could to prevent myself from rolling down that financial hill. Luckily, there are things people can address to take care of virtually every point of this story.
Have a plan
What exactly would you do if you lost your job today? What would you do if your car wouldn’t start today and needed a $3,000 repair? What would you do if you found out you had cancer today?
Do you have a plan? Or would you just panic?
It is much easier for people to imagine that their future is bright and perfect. I’ll always be healthy. I’ll always be able to work. I’ll always be able to go out and start that car and go wherever I want to go.
It’s never fun to think about failure, but spending some time thinking about these events right now when your mind is rational and you can conceive of rational plans to deal with them is far better than addressing them for the first time in a panic.
Have an emergency fund
An emergency fund is the perfect tool to stand in the way of any setback. Cash solves an awful lot of problems. It can pay the bills during a period of job loss. It can cover a car repair bill. It can keep you afloat if your credit card issuer cancels your card. It can help with almost any kind of family emergency.
I recommend that everyone have $1,000 in cash just sitting in their savings account, and everyone without any high-interest debt have at least two months’ worth of living expenses just sitting in cash in their savings accounts.
If you would be in a serious financial pickle if your spouse were to die, you need life insurance on your spouse. The same is true with long-term illnesses – disability insurance is vital. I don’t even need to make the case for health insurance. Auto insurance is usually a legal requirement.
Insurance is your safety net for extreme circumstances that emergency funds can’t cover. If you see situations (that have reasonable chance of occurring) in your life that you wouldn’t be able to handle, get insurance for that situation.
Choose reliable people
Are your friends and family reliable when the chips are down? Think about how they’ve acted when others have been in a pinch. Have they helped those people out? Or have they ran away?
You can also shore up such situations in your own life by standing by people in your life when their chips are down. People really need other people in their lives when things are wrong, and when you show that you’re true to them when they need you, they (and others in your life) are much more likely to be true to you when you need it.