How to Disaster-Proof Your Budget
Avoid financial hardship by implementing a fool-proof strategy
How can you protect yourself from complete financial calamity?
That’s a critical question. I’d like to devote this article to talking about two issues:
First, we’ll review how people find themselves in dire financial straits. What are the conditions that cause this?
Then we’ll talk about three precautions you can take to reduce the chances that you’ll be in a financially stressful place.
Do You Have a Plan for When Financial Disaster Strikes?
What would you do if you or your spouse or significant other got laid off from a job? What would happen?
Unfortunately, many people can’t answer this question. A large number of households have no contingency plan for how they’ll cope in the event one or both spouses loses a job.
As a result, they are one pink slip away from financial disaster.
Perhaps this isn’t your situation, though. Perhaps you already have a plan in place of what would happen if one person got laid off.
Maybe you figured out how to pay for your basic living expenses off of one salary and discretionary expenses off of the other person’s salary. In the event that you are laid off from a job, you could still meet your basic bills. If this is the case, first of all congratulations, you’re ahead of the curb.
What About a Backup Plan?
Second, let me invite you to take part in an additional thought experiment. What would happen if both you and your spouse got laid off at the same time?
In other words, what would happen if your total household income fell to zero? In addition to that, what would happen if your car or your refrigerator broke, or your roof began leaking at a time when one or both of you are unemployed? Would you be able to pay those bills?
Most people haven’t prepared for unexpected situations at all, and many of those who have are underprepared.
Many people are able to deal with one disaster at a time, such as a broken down car, a leaky roof, or a broken appliance, but can’t deal with multiple stressful situations that would hit them all at once.
If you’re either unprepared or underprepared for unexpected financial events, what can you do? Here are a few tips.
1. Build an Emergency Fund
You should maintain between three to six months of your basic living expenses in a savings account. Basic living expenses refer to core essentials such as housing, groceries, gasoline, insurance premiums, utilities, and other basic bills.
Let’s assume for the sake of example that your normal spending comes to $5,000 per month. $2,000 of this is consumed by restaurant meals, clothing, trips to Starbucks, vacations, holidays, gifts, new iPads, and a list of other discretionary expenses. The other $3,000 of this covers your basic bills.
If this is your current budget, then you would want to save an emergency fund of between $9,000 to $18,000. This is enough to cover between three to six months of your basic bills.
2. Pay Off Debt
The lower your bills, the better of a position you’ll be in if a financial disaster strikes. One of the easiest ways to lower your bills is by getting rid of any existing debt.
There are two theories about how to get rid of your debt. One theory called debt stacking states that you should make a list of all your debt based on the interest rate.
You then throw every spare dime at the debt with the highest interest rate, maintain your minimum payments on all other debts (of course), and throw every additional dollar that you have on the one with the highest interest.
The other theory is called the debt snowball. It states that you should make a list of your debt ranging from smallest to largest balance. You then make the minimum payments on all of your debts and throw every spare dollar that you have at the smallest debt.
Once you’ve wiped that off of your list, you’ll feel the thrill of a victory, which will provide the motivation for you to continue going. The debt snowball theory uses the principle of many small wins to keep you motivated.
It's based around the idea that good financial management is not a mathematical issue, as much as it is a motivational one. Try either of these strategies; neither one is better or worse than the other.
Pick whichever one works for you. If you try one and it doesn’t seem to be working, try the other and use whichever method gives you more success.
3. Reduce Your Other Basic Bills
Your three largest expense categories are housing, transportation, and food. Keep these three categories low. Live in a smaller, less expensive house than you are able to qualify to live in. Drive a used car or live in an area where you can use public transportation or walk. Cook home often to reduce your food bill.
The lower you can keep your basic monthly expenses, the more flexibility you will have within your budget. This flexibility will come in handy in case you ever get struck by a financial disaster.