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On Finance: Lines of Defense for Life Events
Money is a tool which allows us to accomplish various things in our lives. To a large extent financial strength and stability is really about our ability to handle life events which, invariably, trigger a financial need. An important aspect of financial planning is building various lines of defense for handling the costs of these events. With strong lines of defense we can focus on all the other aspect of the events. If we don’t have adequate lines of defense we add the burden of financial stress into the difficulties already inherent in the events.
Life events come in all flavors. There are events we expect, which are part of our financial plan such as retirement or purchasing a house . They can also be unexpected events such as car repairs, a major medical crisis, or the loss of a job. Our primary task in life planning should be to build up the resources to handle them to the best of our ability. The stronger and more varied the lines of defense, the more and larger events we can handle with less stress. From start to finish, the lines of defense built will determine how well we’ll be able to manage when things happen.
A word about prevention: A good defense includes a good offense. Be proactive and consider the most likely life events and find ways to prevent or minimize the size and/or impact of them. Obviously financial planning is the a good preventative action. Other actions might include inspections and maintenance of expensive and/or critical assets such a house, cars, equipment, and jewelry. Develop and maintain good physical fitness and having regular physicals. Minimize the chance and impact of incidents around the house by installing fire extinguishers, smoke detectors, basement flood warnings, battery backup sump pumps, CO2 detectors. Even getting regular job training to assure you have marketable skills can be an important preventative act.
Once something happens we need to handle it. From a financial side we start working our way through the available resources. Here are the typical lines of defense, in the order most use them:
INSURANCE: We often think about insurance as protecting us from the bills that come in after something happens. In reality insurance is used to protect our financial assets from the impact of the most common and expensive events. Without insurance a few life event, such as a medical crisis or accident, can drain every other financial asset we have built. An event can put to waste years of good financial planning and management. If we have it when you need it, insurance is as good as gold — if we don’t have it then you’d better have a lot of gold. Viewing insurance from this point of view tends to change how we view our insurance coverage.
CASH ON HAND: The next logical place we turn to is the cash in out bank accounts (checking, savings, CDs). This usually is good for the smaller events. If everything is handled with these funds then life is much easier.
INVESTMENTS: When insurance and cash on hand doesn’t cover it we have to turn to our investments. In a comprehensive financial plan part of our investments were set aside for short-term needs to meet both planned and unplanned events. When those run out we move to liquidate our long-term investments and, finally, tap our precious retirement accounts (with penalties).
HARD ASSETS/EQUITY: Because selling hard assets, such as a house or car, takes time most people using hard assets only for events which have a long-term financial impact — or to manage the ongoing impact of using other methods to meet the need.
As you work on your financial plans consider the lines of defense for life events. This will help you organize your thinking and planning. It should help clarify what area to put your money first, and where later.
So where is debt in the lines of defense? I don’t really consider debt a part of the standard lines of defense for handling life event. Using debt is an indication that the other lines of defense have failed to work. Hopefully they have at least taken some of the impact.
We need to keep in mind that, even for those who have perfectly planned and managed their finances, there are events simply overwhelm the available resources. This is the perfect time for us still working on our finances to step up and offer a hand… “There but by the grace of God go I.”
Posted by Paul Gernhardt on Monday, January 05, 2009