How to Prepare for Unexpected Expenses
You've set up a strong saving habit, your insurance coverages are all up to date and you've got a sound investment plan—all savvy strategies on the road to financial stability. But no matter how well you plan your finances, no one is immune to the unforeseen, which can crack even the sturdiest of foundations.
Here are some ways you can prepare for the unexpected and any financial mishaps that could otherwise derail your carefully laid plans.
Keep a buffer in your checking account
When a financial crisis arises, you typically need to get your hands on cash quickly. Knowing that bank transfers between your accounts can take days—be it savings, money market or other accounts—you'll want to leave some padding in your go-to checking account.
The first thing you should do is find out how long transfers take at your financial institution. Some transfers can take up to 5 business days, for instance. Then, keep a large-enough buffer of money in your checking account for situations when you need cash but can't wait that long for it to arrive.
How much of a buffer you keep in your checking account depends on whether your savings or money market accounts are held at the same institution. Keeping your checking and savings accounts at the same bank means you can usually transfer money more quickly.
Some financial institutions allow you to link your savings to your checking for overdraft protection, letting you keep the bulk of your overflow funds in an account with higher interest. It also minimizes any delay in transferring funds, which can sometimes be the difference between getting something paid on time or receiving late fees on top of your missed payment.
If you bank at two different institutions, then it'll take several days to transfer money between them. In this case, you might want to keep a buffer of about one paycheck in your checking account as a precaution.
Balance building your nest egg and having accessible funds
Many accounts and investment vehicles that earn you more money—including retirement investments and mutual funds—have restrictions on when you can access the principal. That's why your investment and savings strategy should include a risk assessment regarding money accessibility.
Take steps to ensure you can get enough of your money when needed. For example, you might consider fully funding your emergency reserves in a high-yield savings account, or balancing retirement investments between accounts with more flexible withdrawal rules.
Because your investments are likely set to achieve a specific objective of your overall plan, it's important to recognize that distributing funds from these accounts could be disruptive to your investing strategy. It could also expose you to fees and penalties and trigger a taxable event, all of which could reduce the actual capital that makes it out of the accounts. These are considerations to keep in mind and another reason why having a dedicated emergency account is critical.
Find the right balance between earning as much on your money as you can and leaving enough of your money in an accessible account, should you need it. Just as you should understand how long it'll take to receive a transfer, you should talk to your investment professional to clarify how quickly you can access money that's been invested.
Give your credit utilization ratio a check-up
One great benefit of having a credit card is that you can use it as a backup spending tool, given that there's typically a 28-day grace period where you're not charged interest if you pay the balance in full. This gives you more time to move money around.
Still, it's important to keep an eye on your credit utilization ratio, which experts agree should be kept under 30%. The less you've used your credit, the more you'll have in case you need to use it. Also, with a lower credit utilization ratio, you'll be more likely to get a good loan term if you need one in the future.
That said, you may want to think twice about aiming for a 0% utilization ratio. In general, to achieve an optimal credit score, you need to use your credit sparingly. Maintaining at least a trickle of activity on your card and paying it off each month can make you look like a more responsible credit user than someone who pays off a card and either closes the account or leaves it dormant.
Another smart credit move for homeowners could be applying for a home equity line of credit, or HELOC, before you actually need to use it. By applying for one ahead of time when you're in a solid financial position, you won't risk being denied in the event that an unforeseen financial mishap—such as losing your income—makes you less qualified to open one.
Review your insurance policies
One potential financial expense that's easy to overlook is the cost of insurance deductibles, which could come into play in an unexpected situation.
How much would it cost you if you got into a car accident, for instance? What if you have a homeowner's insurance policy claim against your property or experience a severe health issue that requires a hospital stay?
To answer these questions, add up your insurance policy deductibles—and make sure you're accounting for these in your emergency fund calculations.
A periodic review of your life insurance policies is a must to prepare for the unexpected. Consider your coverage strategies, as they often grow in complexity as you mature, develop as a professional and gather assets. You'll also want to review and possibly update your beneficiaries, deductibles and protection amounts.
Pursue estate planning
Estate planning is something that many neglect for too long.
It's easy to fail to consider how much your loved ones' quality of life could be affected in the event of a death. Could they continue to afford the home they currently live in or the school their kids attend? Would they be able to retire comfortably?
You may want to talk with an estate planning attorney to protect your and your family's way of life if someone passes or becomes impaired. Estate planning attorneys can help with carrying out your wishes if you die or aren't able to care for yourself. This includes actions such as designating beneficiaries, establishing a durable power of attorney and finding ways to reduce tax burdens on the estate.
Creating a safety net to buffer you from unexpected expenses doesn't need to be difficult, but it does involve planning to cover all your bases. A financial professional can help you develop a strategy based on your current situation and your goals for the future. This will help prepare you for life's inevitable curveballs when they come your way. And as your needs change over time, they'll help you revisit and adjust your strategy.
A few financial insights for your life
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