Financial emergencies: 6 tips for coping
March 21, 2012
A great deal of financial advice is focused on keeping you out of trouble, but sometimes trouble happens. When it does, your attention should turn to handling that trouble as smoothly as possible.
Here are six tips for coping with, and recovering from, a financial emergency:
1. Preparation is key
You'll find emergencies much easier to deal with if you have an emergency fund built up. This should be money readily available in savings accounts, money market accounts or other readily-available deposit vehicles.
People frequently ask how much they should keep in an emergency fund. Start by building up enough to cover the amount of the deductible on your car insurance. Assuming you need your car to get to work, having enough to cover the deductible is a way of preventing a traffic accident from becoming an even bigger problem.
Once you have that amount set aside, try to keep building emergency savings until you have about five months of living expenses saved. Why? Because according to the Bureau of Labor Statistics, as of early 2012, the median stint of unemployment now lasts about 21 weeks, or about five months. Unemployment is an all-too-common financial emergency that merits preparation.
2. Be wary of sacrificing long-term assets for short-term needs
One reason for keeping emergency funds in savings accounts is so you don't have to sell stocks or other long-term assets at an inopportune time. Also, breaking into retirement funds for immediate needs can have tax consequences.
3. Conduct immediate budget triage
If you find yourself in a squeeze, immediately take a hard look at your budget and decide which expenses can be reduced or eliminated, at least temporarily. Don't wait until you are out of money. Cutting expenses is most effective if you do it as soon as you know there could be a problem.
4. Don't burn bridges
Defaulting on a credit card or walking away from a mortgage may seem tempting in times of trouble, but it will only make your financing options more limited and more expensive in the long run. Besides, reneging on obligations just isn't the American way.
5. Prioritize your debt reduction
You may need to incur debt to see you through an emergency, but then you need to start reducing it in an orderly manner. Target first that debt which is most expensive, and which is most easily re-inflated if need be. For example, accelerated payments on a mortgage may starve you of liquidity that is tough to replace, while credit card debt can be accessed again more easily.
6. Rebuild savings
As soon as the emergency is over, plan to get your savings back on track -- not simply for the next emergency, but ideally for a more orderly future beyond that.
You can't anticipate everything, but if you learn to cope with and recover from emergencies effectively, you'll be better prepared for whatever life throws at you.