It remains to be seen whether or not the worst has passed, or if we are merely enjoying the relative calm during the eye of the latest financial storm. I personally believe we are in for more tough times in the near term.
A variety of stimulus programs have conspired to create an “artificial demand” that has produced seemingly positive results. However, I believe it only served to delay the inevitable. In fact, I’ll go a step further. I believe it made the inevitable even worse. Would the economy have been worse without the stimulus? Probably. Would we have survived and saved a couple trillion dollars in new debt? Probably. But who knows. I’m not an economist, and I certainly don’t play one on TV.
In the Frugal household we are hunkering down, financially. The 2008 recession caught us off guard. We were still in debt, had little savings, and were just beginning to deal with what would become a year-long medical and financial crisis with my mom, who suffered an aneurysm and subsequent stroke at 53 years young. She passed away in September of 2009. Fortunately, we were able to ride the storm out, but I made it a goal to be better prepared next time. And next time may be closer than any of us think.
What if I’m wrong? Well, I hope I am. You can say I told you so. But even if I am wrong about another economic downturn in the next year, at least your family will have improved its finances between now and then.
#1 Get Your Financial Documents in Order
The time to organize financial documents is before a crisis hits. Buy a file cabinet to store things like financial statements, and a fire-proof box to store more important documents, such as life insurance policy statements, deeds and titles, etc.
Action Item: Spend Saturday morning getting organized. Shred all but the last two monthly statements from banks, brokerages and credit cards (unless you need them for tax purposes). Start a “2010 Taxes” file to collect receipts and tax documents for this year. Work up a document with account numbers, rough balances, contact information and save both a digital copy and hard copy in your fire-proof box. Be sure your will and advanced directive for health care is up to date.
#2 Reduce Your Monthly Bills
Who wouldn’t like to save money every month? In many cases the only thing stopping us is ourselves. We get complacent. We don’t like change. But in some cases, you must endure changes to save money in the long run.
Take a look at your recurring monthly expenses and find ways to slash costs. Shop for cheaper car insurance. Ask your cable provider if they offer a basic package. Using just a fraction of your cell phone minutes? Move to a cheaper plan, or consider going pre-paid. Ask your credit card company for a lower interest rate. Even if you strike out at all of these, it doesn’t hurt to ask, and you could easily find ways to shave $50-$100 a month off your regular expenses.
Action Item: OK, so you spent Saturday morning getting organized. Spend Saturday afternoon shopping for better deals. If you find customer service departments closed for the weekend, make a note and call back Monday morning.
#3 Save Three Months of “Living Expenses”
This is essentially a bare-minimum household emergency fund. It won’t last long in a real crisis, but if you have debt, you need to get on with the next step, so avoid saving more than a few months.
Action item: Open a savings account at a top online bank and save three months worth of housing payments, plus enough for food and lights. That’s it.
#4 Get Out of Debt
With a small household emergency fund in place, turn your attention to getting out of debt. Household debt adds considerable risk to a family’s finances. It puts you so close to the edge, financially, that it doesn’t take much to push you over the cliff. Distance yourself from the edge by getting radical in your approach to paying off debt.
Action Item: Pay off 100% of your household debt, beginning with credit cards and any other unsecured debt. Sell stuff, donate plasma, get two part-time jobs – get radical and get out now! Your family’s financial future depends on it. More on how to get out of debt.
#5 Pile Up a One-Year Household Safety Net in Cash
Now that you are debt free, return your focus to emergency savings, but continue to work on items 5-8 concurrently, allocating a bit of your income to each step. How much? Do what you are comfortable with, but make reaching milestone a priority.
Over the years, I’ve waffled a bit on how much should be in a fully-funded emergency fund. Experts recommend 3-6 months of expenses. Some personal finance bloggers recommend establishing an emergency fund based on the number of dependents, or the number of people working in the household. Both are good ideas.
However, from this point forward, I’ve decided to offer the following advice to keep things simple: save one year of basic household expenses as an ultimate family safety net. Considering the recent recession (and the chance of a double-dip recession around the corner), the old advice of 3-6 months being sufficient to cover a period of unemployment or serious illness is, frankly, a joke.
Action Item: Save one year of basic household expenses in a highly-liquid emergency fund. Note, this should only cover basic household expenses. Luxuries such as cable, Netflix, XM radio, and gym memberships should not be included. Things like mortgage payments, food, the power bill, and transportation costs should be included.
#6 Build a Second Income
I can think of no greater hedge against unemployment than developing a second income stream. Even if your second income is a fraction of your full-time income, it may be enough to keep your house current and food on the table in a financial crisis. Part time gigs are a fine way to boost cash flow in the near term (a great way to get out of debt, for example), but I encourage you to look for opportunities to cultivate self employment income. Mow yards in your neighborhood. Learn to build fences and decks on the weekends. Start a blog or chase down freelance writing opportunities. Get creative.
Action Item: Start a side hustle at nights and on the weekends.
#7 Keep a Modest Stockpile of Food and Household Goods
I have known some people to fill entire rooms with stockpiles of food, and load up basements and storage buildings or garages with paper products and cleaning supplies. I have known others who have no more than tomorrow night’s dinner scattered about bare refrigerators and pantries. Like everything else, you have to find a balance that works for you.
We don’t like to shop, and have found that the more often we are in the store the more money we spend. So, we try to keep a small stockpile of food at home and only restock a couple times a month. In a real crisis, we could probably go a month or two without having to leave the house for food. Of course, we’d sure miss fresh fruits and vegetables, so we try to grow a few of those on our own using square foot gardening methods in our backyard.
Action Item: Clear a few shelves and stock with non-perishable (or long shelf-life) foods like rice, beans, canned vegetables, plus a small surplus of paper and cleaning supplies, toiletries, etc. Keep your freezer well-stocked with a variety of meats purchased on sale.
#8 Pay Off Your Mortgage Early
For us, the ultimate in financial freedom begins with having a paid-for home. Imagine not making payments to anyone for living space (well, except the local tax commissioner). No monthly mortgage or rent payments buys two very important things: You can build wealth much faster without house payments, and you can survive on much less income without a mortgage.
Action Item: Get busy paying off your mortgage early. Contact your mortgage company and ask about making biweekly payments. If they offer a biweekly plan, but charge a fee, pass and simply send in one extra payment a year (the math is virtually the same). If you are in relatively good shape, financially, have plenty of emergency cash saved, and are saving for retirement and kid’s college, consider throwing extra savings at the mortgage each month. Contact your mortgage provider and ask for instructions on making extra principal payments.