When did you last stress test your finances?
2020 has been a year of great uncertainty. Of course Covid-19 has dominated the landscape, bringing with it insecurity for some people around both their health and also their economic circumstances. As countries are moving in and out of various states of lockdown, for many people this is creating a lot of worry about their jobs. For some this is temporary and they can see a relatively swift return to normality. For others their prospects are more bleak, as they are forced to close their business or they see their employers reducing headcount or shutting down altogether.
Now is a really appropriate time to stress test your finances in light of the economic challenges that Ireland is currently facing.
If you have a mortgage, your bank will have carried this out when lending you the money – after all, their primary goal is to get their money back! They would have sought clarity in your ability to repay the loan. However they also have security over your home, so if all else fails they still have plenty of leverage to up the pressure on you…
Stress testing of your finances should not just be a once-off exercise carried out by a bank – it makes sense for you to periodically examine your capability to withstand a sudden financial shock.
The place to start is to consider the risks to your finances and the likelihood of them coming under pressure. These can probably be summarised in the three main areas below. For each of them, there is a range of strategies to consider in order to bolster your finances.
Your income security
This can of course be susceptible to a range of shocks, as we are seeing today. Economies can suddenly and swiftly plummet due to a range of factors (a pandemic only being one of them), and as a result companies can end up shutting down. Closer to home, your own business or the company you work for may struggle as a result of changing market dynamics, increased competition or simply poor performance. What’s the likely threat to your income?
To protect against a potential loss of income, you can always look for ways to advance your career and indeed create multiple sources of income. In addition to this, build up an emergency fund that will cover at least 6 months of expenses in case your income disappeared. Failing this, is there another source of cash that you can tap into if needed, such as a benevolent family member?
Retirees should consider their ability to withstand sharp falls in their investments. Should this happen, would you then be forced to sell assets in a depressed market? Talk to us about avoiding this scenario.
Your spending
Live within your means, and this includes keeping money aside for emergencies. One of the biggest mistakes people make is to live on the very limits of their finances. If something goes wrong then, they are immediately in trouble.
Have a household budget and stick to it. This should include your day-to-day spending and big purchases – holidays, changing the car and home improvements. Wherever possible, these should be funded by savings as opposed to borrowings. Don’t take on debt that might appear well within your means, but will become unsustainable if interest rates rise or you suffer a shock to your income. If you are not paying off your credit card in full each month, it’s time to take action – this is a major alarm bell…
Your health
Your physical and mental health are really important drivers of your financial security too. After all, without these your ability to earn income may be compromised and your expenses may also increase as a result of care costs etc.
The starting point is to live well and stay healthy. Having a good diet, exercising regularly and looking after your mental health are each very important factors in helping you to live a more rewarding life and in building your resilience to deal with the slings and arrows of life and any financial shocks.
However sometimes unfortunately ill-health just visits your door. How will you deal with this? Are generous sick-pay benefits available to you, or do you have sufficient income protection and specified illness cover to deal with these scenarios?
In stress testing your finances, consider all of these areas in turn. Are their specific actions that you can start to take today that will strengthen your ability to deal with an unexpected financial shock? If there is, now is the time to take action and to build your confidence and capability to deal with any unexpected events in the future.