Tuesday, November 6, 2007

Getting Ready for the Unknown

You may think that you are ready – but reality has a way of “getting you”. Think about the readiness of FEMA and it’s handling of the Katrina crisis. FEMA thought they were ready and competent to handle any crisis – how wrong was that assumption. Or consider the hedge fund strategies used by the two Bear Sterns funds that went bust recently. The hedge fund managers had planned for all relevant scenarios but reality was significantly different. Similarly we can plan and prepare for our financial well-being but our resolve is periodically tested. And we don’t have to create a situation – life usually throws a curve ball that our financial plans have to deal with. That is the ultimate test of any financial plan and strategy.

You may have a savings goal that can get blown away during the holidays. Or (like I did last weekend) you may end up hosting some guests and end up spending more than planned on food, entertainment and sight seeing. You may blow your budget on vacation or holiday shopping. You may assume an unrealistic return on your portfolio (the recent bull market is making us complacent about risk and greedy about large returns). And there are life situations that can throw the best laid financials plan awry – birth, death, marriage, divorce, college, job, parents …

My sentiment on readiness covers both the proactive and reactive

Financial Contingency – You plan for the unknowns by creating a financial contingency plan - a financial buffer to tide you over the financial difficulty you encountered. This contingency is for the truly unknown event in your life. Experts recommend 3-6 months of living expenses as a buffer – that may be a good starting point.

Another option is to create a slush fund that can be used to fund the various spending temptations you come across. The slush fund will shield your core savings and investing strategies from being adversely impacted.

Lessons Learned – When you are hit with a surprise (and it will happen) – deal with it the best you can but don’t forget about it. Review it, analyze it and figure out how to avoid this situation in the future. Learn a lesson from the situation – update your readiness for the next time. If the stock market undergoes a correction and your first reaction is sell and run – stop! The ups and downs of the market should be used to review your allocation, diversification and investment strategy and tweak it as appropriate. Remember – the smart learn from their mistakes and become stronger, the fool makes the same mistake over and over again but expects a different outcome.

Be ready for an event that will test your financial readiness – plan for a financial crisis, learn from it and become financially smarter.


Anonymous said...

My family lived through the monster flooding in the Midwest back in 1993. It was horrible and destroyed so much. We were lucky compared to most people in our neighborhood. It literally missed our first floor by 1/2 an inch. It destroyed our furnace, water heater, electrical fusebox and wiring, and many personal possessions. It also was 2 feet deep in our garage and wreaked havoc in there as well.
Your right, you just really never know what tomorrow will bring. We did learn many lessons from this experience and are grateful our loss was just in the material sense.
Great Article, the topic is something everyone should take time to think about in their own lives.

Bryan_T said...

Great post. Kiplinger.com just profiled the importance of insurance and how it can provide protection against the unknown natural disasters. Read the article at Lessons From the California Wildfires