Friday, August 7, 2009

Lessons Learned Part 1

Lessons Learned Part 1

What can we learn from the complete financial meltdown over the last year that can help our personal finances going forward? One lesson learned is that denying the existence of those unread quarterly investment statements on the kitchen counter will not make the pain go away (or will it?) Throughout the next few posts I will review the top 5 lessons learned and how we can utilize them to make our financial situation better the next time the financial bear wants to take a bite out of our assets.

I know we have all read about how we should have an emergency fund with 3 to 6 months of resources available to pay the bills in case times get a little tight. But what happens when the financial storm makes Hugo look like a calm breeze? I have yet to meet anyone who anticipated this level of financial disaster. If you had asked anyone on the street one year ago if they would have foreseen in their crystal ball 68 banks being seized by the FDIC (just in 2009), breaking the buck on The Reserve Primary Money Market Fund, the federal takeover of both Fannie Mae and Freddie Mac, the bankruptcies of Bear Stearns, Lehman Brothers, General Motors, Hollywood Video, Sharper Image, Circuit City, Eddie Bauer, Dunkin Donuts (say it isn’t so), CiCi’s Pizza, KB Toys, Mervyn’s, Mrs. Fields famous brands, Chrysler, Wickes Furniture Company, IndyMac Bank, Goody’s, Lillian Vernon, Linens and Things, and Washington Mutual just to name a few, the complete meltdown of the housing market, overnight rates at 0%, government economic stimulus in the trillions, Madoff-like investment scandals (the likes of which have never been seen before), retirement accounts losing trillions (that’s right it is the second time I mentioned trillions with a t), millions of jobs lost, quite simply they would have said no.

What can all of this teach us looking back upon the last year in crystal clear 20/20 hindsight? Quite simply nobody has a clue what the future looks like, even though there are plenty of financial gurus who want you to believe they can. Since we cannot fully understand what lies ahead let’s get prepared for the unknown in three easy steps.

Step 1 Analyze- It does not matter if you are a company or an individual you should spend some time analyzing exactly what your cash flow needs are. How much cash do you burn through on a daily, weekly, and monthly basis? What kinds of expenses are necessary (food, water, shelter etc.) and how much do they cost? What kinds of discretionary spending can be eliminated (do you really need 7 horse racing channels with the 213 other channels you don’t watch?). What types of risks are out there? Are you in a field with a huge employment demand regardless of the economic situation? Or are you in a new job and if things get tight your position will be the first to go? If you were laid off how long would it realistically take you to find a comparable job? If you can’t find a comparable job what expenses are you going to cut if you have to take a lower paying job? If you become disabled how many months will pass before your disability insurance coverage kicks in (you do have disability insurance coverage right?). The whole idea behind this exercise is to really think about and analyze all of the potential negative events lurking out there that could disrupt your finances.

Step 2 Quantify- Now that you have analyzed your cash inflow, outflows, and risks etc. lets develop a quick down and dirty emergency budget. It’s time to put dollars and cents to each of the items you analyzed in the first step. How much money do you need to survive for one month based on the above criteria? How much money do you have coming in (unemployment, disability, or no money at all)? How much money do you have going out? The difference between the two is the amount you will need to save in order to cover yourself for one month. Now, there are varying opinions out there as to how many months of reserves you will need. A simple rule of thumb I use is if you are in a riskier situation (one income family, high risk job, etc.) you should have at least 6 months of your down and dirty emergency budgeted figure saved up. You can get away with less if you are a two income family or have other immediate sources of income available. More savings is always better because it’s human nature to not accurately project the worst case scenario. As this last financial storm proved it can always be much worse than we originally planned for.

Step 3 Save- Now you have a number in sight so start saving today. Make saving for your new emergency fund a priority. Have a positive attitude about it. This is not drudgery. This is responsibly taking care of yourself, your family, or your company. When investing the money think liquid and safe. "Safe" might be an FDIC insured money market account or a few CD’s laddered out by month. Just make sure you have access to the funds with no disruptions in payments.

If you take action on these three steps now, no matter how fiercely the financial winds blow you will have the satisfaction that you, your family, or your business will never be blown off course. Please feel free to email me your thoughts, comments or questions.

Until next time…be Cents Able.