How To Prevent Your Own Financial Meltdown

You’ve heard it before. I’ve got some good news… and some bad news…

The bad news is that there are certain types of disasters that you will never be adequately prepared for. Astroid strikes and nuclear wars are at the top of the list. Fortunately, those are “Outlier Situations” with a low likelihood of happening.

The good news is that it is relatively easy to prevent your own financial meltdown – a lesson that many financial institutions could have easily remembered, yet failed to.

The basic principles are:

1. Prepare.
2. Reserve.
3. Insure.
4. Conserve.
5. Review.

It’s all about managing risks.

1. Prepare.
Prepare for life’s emergencies. At some point, you (or a family member) are going to get sick, lose a job, need car repairs/replacement, purchase a home, need significant home repairs/replacement, need emergency shelter, or need legal assistance.

By Pookah Finances 201, you can start really thinking ahead. Your mind, along with your ability to plan ahead, is your most powerful asset when dealing with finances. Plan Ahead. Work through a list of “What If’s”. Learn about your family’s medical history. Check with your neighbors or the local city council for what past disasters have struck your neighborhood. Write down what you learn… and what you plan.

2. Reserve.

Set aside enough of your earnings to cover one or two of these emergencies, preferrably the expensive ones. You do NOT have to start out with the most expensive one (probably serious illness). But car replacement/repair is highly likely, as is home repair. Ten thousand dollars is a lot of money – build it up over time. Your emergency fund can act as this sort of reserve.

When it comes to investing, it depends on your level of interest. Index funds are a good choice, in general (though there can be great variability even among index funds). But don’t put every single egg in one basket. An IRA (Roth or Standard), 401K plan, and Emergency Fund are a good start. With a little planning (see 1. Prepare above), you can also take great advantage of a Health Savings Account (HSA) or other vehicle that allows you to reserve some of your money, probably earn interest on it, and then pay for some of those incidents when they crop up. If your interest lie in the direction of direct stock purchases, you can increase your reserves (with attendant market risks) steadily over the long run.

This is akin to keeping enough money in the bank to cover your borrowing – a concept that has direct bearing on the crisis our economy is currently experiencing. You have a (hopefully) rare opportunity to learn several important lessons and take them to heart. This is one of them.

3. Insure.
Insurance, in the United States, is screwed up. It is one of those necessary evils.

Insurance is intended to spread the cost of expensive problems and disasters over a wider population, using the premiums paid by the insured as investments to generate additional money for the insurance company AND to pay for those who file a claim to be repaid.

I do not have the space to go into details about the many, many, many problems and pitfalls of insurance here. But I do offer this advice: Insurance is there as an emergency measure, for when one of the disasters strikes. If your cash flow can handle it, use a high deductable to lower your insurance costs – and keep that emergency fund at three- to five times the deductable. With the exception of medical insurance, insurance is for the “What If’s” – those emergencies that are unusual and tend to be devastating in their effects. What if your house burns down? What if you are in a car accident? What if you are diagnosed with cancer? What if you are killed and your family needs to pay off the house mortgage?

Just one of these events can destroy your finances. Insurance is there to prevent that destruction.

4. Conserve.
Conserve your resources. You can look for ways to cut drains on your resources from the preceding principles. For example, if your emergency fund is at a reasonable $10,000 adjusted for your lifestyle, you can look for ways to cut your expenses. One of the easiest is with a car. If replacing your car with a like make & model would only cost $5,000, talk with your insurance provider about dropping vehicle replacement coverage from your car insurance. How much would it save you per month? Then put that savings towards your emergency fund, until you get it to $15,000+ (three to five times the replacement cost). You can also look at raising your deductible, increasing your emergency fund accordingly, and using the savings for other projects.

Medical insurance is a touchy subject. But if you are regularly on medication to treat a condition, it may be worth your while to seek out either a cure or alternative treatments. To use diabetes as an example, mild cases *may* be controllable solely through dietary changes. Not having to buy medication (insulin, in this case) all the time means that you can improve your cash flow. However, it is up to you to determine if the cost of the cure (or the attempt to get around) the problem is worth it.

You must also ACT CONSERVATIVELY. Are you taking on too much risk by raising your deductibles? What if you have to pay three or four of those deductibles in the same six month period? If your household only generates one bag of trash (because of your extra efforts at frugal living, for example), would it be worthwhile for you to join up with your neighbor and have a “joint trash pickup” service? What are the costs of your employer-provided insurance versus getting your own? (It does happen occasionally that paying for your own insurance is cheaper than accepting your workplace plan.) Ask your doctor if there is a generic or older equivalent of your prescription medication that would cost less, yet still work for you.

Above all, when you are changing something about your finances, THINK: How will this impact me? Does this create too great a risk? What will it cost if the emergency DOES happen?

5. Review.
Review your plans every year, especially the insurance. If you have picked up a few fender-benders or tickets (it happens even to the best of us), check your insurance to see if the monthly cost should have gone done by now. You may very well have gone the required one or two years (or whatever requirements are there for your situation)without an incident to qualify you for the reduced cost. Definitely insist on being pro-rated for any time that has passed before you noticed this cost savings! Or for the cost of a simple blood test, you may be able to demonstrate that you no longer suffer from an expensive, high-premium medical condition (thanks to your efforts to control or cure it), and thereby cut your medical insurance costs down.

This review also introduces a sanity check. After all, if you are at Pookah Finances 201, there is no reason to pay for insurance covering stretch limousine trips to and from the car dealership if you get in a wreck. A phone in combination with bicycle, public transportation, friend, or cab will do just fine. As a counter-point, if you are finding yourself more accident-prone as you get older, maybe you need to lower that deductible to better match your changing life.

I will never forget the neighbor who discovered he’d been paying for his eldest son’s medical insurance into the son’s thirties, when the insurance could no longer cover him once he passed his 21st birthday. (Like most insurance companies, they didn’t want to reimburse him for the overpayment. The state’s Attorney General, and a judge, vehemently disagreed.)

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