While making plans for our finances, we need to keep big changes in mind.
Everyone encounters big changes (and big expenses) at different points in their lives.
Sometimes these big changes are planned! I just had a baby. That was very intentional. It will also make my life much more expensive.
Sometimes these big expenses are unplanned. We can’t predict when we will get sick or injured and face large hospital bills. We can’t predict when we’ll get into a car accident and need to buy a replacement. We can’t predict when our home will flood.
Expensive things happen all the time. Whether planned or unplanned, we need to be prepared.
Planning for expected change is obviously the easier of the two.
You can make sure you have space in your budget and think through the financial ramifications of a change before you actually make it.
My suggestion is that if you know the costs, then pretend to spend that money earlier. For example, if you’re planning to move to a new home, start making the larger mortgage or rent payments to your savings account six months early.
This will ensure that you can comfortably absorb the cost before you commit to making the change.
If you struggle with this new baseline, then you can work to delay the change or find some other way to cover the additional costs.
Either way, you have a heads up that there will be a problem before it becomes real.
Plan for the Worst
If you know some of the costs, then plan as best as you can. And plan for the worst.
For the last few years my wife and I have been cutting back on our spending even as our incomes continued to climb. We knew that at some point we would welcome a child and we wanted to make sure that we could comfortably cover the many associated costs.
In doing so, we attempted to plan for the worst. Financially, the likely worst case scenario is that it would be cheaper for one of us to quit work and forego our income rather than pay for childcare. Based on that, we worked on getting our spending down and our incomes up enough that, if necessary, we could live on one income.
Another helpful thing to remember is that you are probably not the first to make whatever change is on the horizon.
Talk to people that have been through it if you are unsure about costs. Even if you think you are sure about costs, it still helps to talk to someone and see if there is anything you’re missing.
If you don’t know anyone, ask the Internet.
There is nothing new under the sun. If you’re thinking of doing something, then someone else has done something similar before. Ask for help rather than reinventing the wheel.
Sometimes large expenses are not planned. Sometimes emergencies happen. This is where an emergency fund comes in handy.
How much cash you should keep in your emergency fund is a hotly debated topic in the personal finance space.
The conundrum is that a larger emergency fund provides more protection from risk, but it also means that you have less money in the market and you are growing your wealth more slowly.
I’m not here to tell you the right answer to this, because there is no right answer. You need to find a balance that works for you.
With that in mind, there are some general rules to consider.
You can keep a smaller emergency fund if:
- You are part of a two income household
- The two incomes are from different companies and different fields
- You are in a stable job with minimal chance of layoff
- You don’t have dependants
- You have a flexible budget
- You have investments that you can sell off if necessary
- You would be able to quickly pick up freelance work or side job work to bring in some income if you were to lose your job
You should have a larger emergency fund if
- Your income is inconsistent (especially freelancing or gig economy work)
- You are the sole earner for your household
- There are others depending on your income
- Your budget is already bare bones and could not be shrunk much
Beyond that, your emergency fund should be enough to make you feel comfortable. If you would be most comfortable having enough that you could go six months after losing a job without any income on your current budget, then go for it. If you want to keep a small emergency fund and risk selling off some investments, then do you. Personal finance is personal.
Think about the type of emergencies that you could face.
Some of the larger dollar value emergencies are medical emergencies and job loss. Plan for both.
Make sure you have enough cash in your emergency to cover the full deductible on your health insurance. This should cover most of what you need in the event of a medical emergency.
While you can never be truly prepared for the lifetime costs of a worst-case-scenario illness, having enough cash to cover the deductible for at least one year will be a good start.
Similarly, you should prepare for a job loss before it happens.
Before even touching the financial angle, you should always keep your resume up to date and try to keep good relationships with others in your field.
Build a reputation for doing good work and helping others. This helps both in that you will be more satisfied with your work life and social life as well as leading others to be more willing to help you out when you need it.
In preparing financially, think through areas where you could cut your budget ASAP if necessary.
Maybe you decide that if you lose your job you will immediately cut out eating at restaurants and will cancel cable. How much would that cut out of your monthly expenses? What other cuts could you make without too much of an impact on your standard of living?
On the income side of things, you should always have an income Plan B.
How would you make some money if your full time job disappeared tomorrow? Ideally you would find another job making similar money in the same field. But are there ways you could make some money while you search for that job?
Maybe you could pick up some freelancing or consulting in a field in which you are well-versed and connected. Maybe you could pick up some sharing economy work like driving for Uber, delivering for Postmates, or walking dogs for Rover. (If you want more info on gig economy jobs, I highly recommend following Kevin over at Financial Panther.)
If you have a plan to bring in some income, then you won’t have to lean completely on your emergency fund. You don’t need to replace your entire income. Every dollar that you earn will relieve a little bit of strain.
Join the Conversation!
That’s how I have prepared for large expenses thus far in my life. How about you? What are your preferred method? Is there anything that I missed? Let us know in the comments!