April Showers

April 04, 2012

As the saying goes, April showers bring May flowers and if you live in the Southeast like me, you’ve certainly had your share of showers this spring.  As I stare out the window at the falling rain, I’m reminded of the fact that in every financial lifetime, some rain must fall so the bigger question is this: how do I prepare for my financial “rainy day?”  Here is a list of five steps you may want to consider taking this spring so that when, not if, the financial rain comes, you’ll be better prepared.

Step one – Organize

This, unfortunately, is a word that is foreign to my wife.  Her idea of organization is making sure you can see every pile so that you know where to look for stuff.  That works great as long as you are the “Master of the Piles,” but good luck finding stuff quickly if you’re not.  The good news is that most of the information in the piles is related to school events, home improvements, and church functions but every once in a while a financial statement or bill will slip in there.  I can’t tell you how many times I’ve sat at the kitchen counter just looking through the piles only to stumble upon a bill that was due weeks ago.

I can’t imagine that our household is that unique.  As long as the sun is shining on your finances, you may be able to get by organizing your financial affairs this way but don’t be fooled.  Things can change quickly and if you are not able to find important information in a timely manner, you can make a bad situation worse.  Do yourself and your loved ones a favor and get organized.  Whether it’s a filing system or scanning documents electronically, find a way that works for you and use it.  (A word of caution: if you use electronic storage methods, be sure to back up the information in a secure location such as an external hard drive, flash drive, or online storage facility such as www.dropbox.com.)  The Colorado State University Extension has some additional resources you may want to check out.

Step two – Cash Reserve

You knew we couldn’t talk about planning for an emergency without the ubiquitous emergency fund.  Suzie Orman and others would like you to have 8 to 12 month’s expenses set aside but that might take a while.  If you are just getting started, plan to set aside $20 a week for the next year.  That will build your emergency fund up to $1,000 (assuming you don’t tap into it).  Once you clear the $1,000 hurdle, then you can work toward the 8 to 12 month number.  You don’t have to get fancy with it.  A simple checking, savings, or money market account is a good place for this kind of money.

Step three – Insurance

Now there are a lot of different kinds of insurance policies out there but the two that I think are most important are life insurance and property & casualty insurance.  For me, the most significant reason to carry life insurance is to replace my income in the event I die prematurely.  I have four minor children and my wife is a stay-at-home mom, so if I were suddenly out of the picture, it would create a tremendous financial strain on the household.  Not having life insurance or not having enough could be one of the worst things I could do to my loved ones but it is also one of the easiest to remedy.  Your employer may offer paid life insurance as a benefit but that amount is probably not enough.  If they offer you the opportunity to buy additional coverage, I say take it!  It may be the most cost-effective life insurance you have access to.  If you’re not sure how much life insurance to have, check out this article or visit this site.

In addition to life insurance, be sure to carry enough auto and homeowners insurance.  With all the crazy weather we’ve been having lately, you never know when a tree will blow across your yard or when a light rain will make the oil in the road come up, creating havoc on the roadways.  We may not like having to pay the auto insurance bill each month but we’re awfully glad to have the coverage when we need it.

Step four – Trades

My brother called me this weekend concerned about the volatility of the stock market.  The stock he purchased several years ago is finally worth more than he paid for it but he’s concerned that it might go back down in value.  One thing I suggested to him was to place a stop-loss trade order on his position.  A stop-loss order will automatically sell his position when the price of the stock drops to a certain level.  For example, if he paid $75 for his stock and it is now worth $80 a share but he doesn’t want to hold it if it drops below $75 again, he could place the stop-loss order at $75.  Investors should use stop-loss orders to limit the downside of their investments.  Be careful, though.  Orders expire after a certain period of time so make sure you know how long your order is good for and renew the order if necessary to maintain the downside protection.

One thing to note – you cannot place stop-loss orders on mutual funds but you can place them on exchange-traded funds (ETFs).  For this reason, mutual fund holders may have to be more diligent when it comes to monitoring the performance of their investments.

Step five – Estate Planning

In addition to being organized with your financial affairs, it is just as important to have critical documents in place that give specific instructions and authorization to others when needed.  The four most basic documents all estate plans should have include a will, durable financial power of attorney, living will (i.e. healthcare directive), and healthcare power of attorney.  A will provides instructions regarding the disposition of your probated assets after your death while a living will provides instructions for the type of healthcare and medical treatment you would like to receive in the event of your incapacitation.  A financial power of attorney gives someone else permission to make financial decisions for you while a healthcare power of attorney gives someone authorization to provide medical care instructions to attending medical practitioners.  Keep these and other critical documents in a safe, fire-proof place, and tell only those that need to know where they can find them.

While it is always good to take steps to avoid financial rainy days, chances are they will happen to you sooner or later.  With that in mind, it’s best to be prepared for what could happen.  Remember, the rain brings about the flowers and sunny days are sure to come.  Taking these steps should hopefully make the sunny days come a little sooner.