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Thursday, February 16, 2017

Financial Resilience: Part 1 of 3

Noun: the capacity to recover quickly from difficulties; toughness.

Too often what we see as advisors is a focus on accumulation and growth in a portfolio. While there is no denying that long-term growth is an important part of financial success, a too-often-neglected component of financial planning is building financial resilience, not only within a portfolio, but also outside of the portfolio. Three opportunities for building financial resilience include individual resilience, family resilience, and community resilience.

Individual resilience is founded on the knowledge, experience, and systems in place that insulate your lifestyle from the ups and downs of your portfolio. The caricature of individual resilience is the image of the “doomsday pepper.” Completely self-sufficient, providing their own food, water, and energy, their lifestyles would remain largely unaffected regardless of the performance of the stock market. A more realistic component of individual resilience for individuals are the following:

1.      Emergency Fund: how many months worth of expenses do you have liquid and available in the event of an emergency or job loss? Cash savings are the first line of defense against the many threats to your financial security. Without these reserves, urgent and unexpected expenses are financed onto a credit card or other debt, to the detriment of our future well-being.

2.      Cash Flow Margin: How much of your income is eaten up by lifestyle expenses? How much is left over at the end of the month? The narrower the margin between your income and your outgo reduces the flexibility in the event that your cash flow is disrupted due to disability, emergency, or lay off.

3.      Income protection: Speaking of disability, is your income adequately protected against the threat of a long-term illness or accident? Even though many employers offer Long-Term Disability Insurance (LTDI) as a benefit, often those benefits (perhaps only 60% of your salary) are taxable, leaving you with close to half of your normal base pay.

4.      Occupational Risk: On the topic of income, how much does your job depend on the economy staying business-as-usual? If there was a downturn or upset in the market, would you be at a greater risk of layoff or being forced to take a pay cut?

5.      Credit Risk: You may think that having a line of credit on a credit card or against your home equity gives you the same protection as an emergency fund. However, the limits and terms on these products can often change with the economy. Without a liquid emergency fund, you can see credit evaporate or rates increase, just when you need it the most.

6.      Personal liability: A feature of most all auto and homeowners policies is liability coverage, but many individuals have no idea whether theirs is adequate. Especially as your net worth increases, so does the likelihood that you might be the defendant of a lawsuit if you are in an accident. I will leave the specifics on how to insure property to an insurance agent, but protecting yourself against the litigious nature of our society is a necessary step in increasing your resilience.

These are six critical areas for building resilient wealth that are often glossed over in financial planning for individuals. Please stay tuned for Part 2 of the series; Family Resilience.

Geoffrey Sadek, CFP®

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.