Money & Career
Five Ways to Prepare for a Financial Emergency
5/1/2019 1:00:00 PM

Financial Emergency


What would happen if you were hit with an unexpected medical bill, a layoff, or your adult son or daughter needed a quick loan to get out of a financial jam? According to the Federal Reserve’s Report on the Economic Well-Being of U.S. Households in 2017, 40 percent of respondents said they wouldn't be able to cover a $400 emergency expense. Nearly 80 percent of American workers say they live paycheck to paycheck.If you are one of the millions of Americans who find themselves in a similar precarious financial situation, read on for some practical advice. 


1. Build up a cash reserve. To protect yourself and your family, you should ideally have enough cash available to cover a minimum of three months of essential expenses; for some people, six months is better.  

It may sound like a lot, but you can build it up slowly. Your goal is to spend less than you earn and make monthly deposits to your emergency fund a part of your budget. Setting up automatic payments to this account makes the process even easier. Then commit to not touching this money unless there's a real financial emergency.


2. Reduce your consumer debt. This implies debt such as credit card balances. Focus on bringing these down to zero—and keeping them that way—while you continue to pay your mortgage, student loans, or car payments. Do this now before an emergency strikes so you won't be faced with missing any payments. 


3. Have credit available. While this may sound like the opposite of point #2, it's really not. It actually has more to do with keeping a good credit rating (see page __) so if you need to rely on credit for a short period of time, you'll have it available. This includes paying your bills on time as well as keeping your credit card balances low. If you own your home, consider establishing a home equity line of credit. This can provide an additional cash resource to back up your emergency savings. You only pay interest on the money you use. Of course, you have to pay it back, but the payment schedule and interest rate may be more favorable than using a credit card. To be clear, though, borrowing against your home is effectively a second mortgage and can increase your risk if not used wisely. It’s not a substitute for an emergency savings account.  


4. Have adequate insurance. Health insurance is an absolute must, as well as automobile and homeowner’s insurance if you own a vehicle and your home. But don't forget to plan for deductibles and maximum out-of-pocket expenses. These can be significant (depending on your policy and your health) and factor into how much you should have in emergency savings.

Once you have the basics covered, you should also consider personal liability insurance, disability insurance, and long-term care insurance. This sounds like a lot of insurance (and a lot of additional expense), but sound insurance planning can help you avoid a financial catastrophe and ultimately reduce the size of the emergency savings you may need. 


5. Keep your short-term money safe. Any money that you believe you might need in the next three years should not be in the stock market. Good choices for your emergency fund (and other money that you may need soon) are checking, savings, money market accounts, and possibly short-term bonds or CDs in the mix. Cash or cash equivalents may not earn much over the long term, but they will give you the most flexibility and protection from a loss in the short term.


What to do if you find yourself in a financial jam

Even the best-laid plans can be upended by an unexpected crisis. If you find yourself struggling financially, here are a few things you can do to help ease your burden until things get better.


First, carefully examine your expenses and reprioritize your spending. Cut out everything but the essentials—things like mortgage or rent, food, utilities, and insurance. Pay the minimum on outstanding credit or loan balances. If you're unable to pay a bill, contact your creditors right away. They may be willing to negotiate a payment schedule or waive late fees. Try to do this yourself before signing up for a debt management or consolidation scheme. Some of these programs may overpromise and under-deliver and force you to incur additional costs.  

Finally, even if it's possible to borrow from your 401(k) or take a distribution from your IRA, consider this a last resort. While present circumstances may be difficult, avoid jeopardizing your future retirement unless absolutely necessary. You may not appreciate the full costs until much later.

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