The coronavirus pandemic has challenged the physical wellness of people all over the world. As of this writing, the total number of people infected has exceeded 10 Million. It has exposed how poorly prepared many have been to deal with a severe health crisis. It has also exposed how poorly prepared, financially, so many are to handle a crisis, of any size.
We are all taking extraordinary measures to avoid becoming infected, and we will react very differently (or we should) to future flu/virus seasons. Procedures like social distancing, wearing protective masks, sanitizing our hands, and the surfaces all around us, limiting travel and large gatherings have all become the “New Normal” for most of us. We have experienced the value of stockpiling toilet paper, pasta sauce, frozen pizza, and hand sanitizer.
We need to apply those kinds of procedures to our “New Financial Normal” so that we are not blind-sided by the next financial crisis in our lives. But, where does that preparation start? Creating a $1000 Emergency Fund is THE place to begin. It is a resource that is immediately liquid (think checking, savings, or Money Market accounts), and just beyond your fingertips so you are not tempted to raid it when you have overspent on something that is not an emergency. It also keeps you from creating additional debt to meet a current crisis.
Many people will use a credit card to finance those life emergencies. But what is the math of that process? The average expense financed on a credit card is $3500. At the average national interest rate of 17%, that would require a monthly payment of $125 for 3 years to pay off that debt, incurring an additional $1000 of finance charges. (You just paid $4500 for that $3500 emergency). Unfortunately, it is not just emergency spending that causes the problem. If you put that $3500 vacation on the credit card, it could cost you $4500 too. A full Emergency Fund, ultimately, should be 3-6 months of your expenses.
The next step, after creating that Emergency Fund, it to start eliminating your debts. However, you can’t start that process until you know how much money you have available to retire those debts. I could always spread any extra funds I have against all my outstanding debts (the shotgun approach) to whittle away at those balances. Unfortunately, you never seem to get anywhere with that process.
The best place to start is by creating a budget. A budget is a plan to determine where your money comes from (income) and where it needs to go (bills, debts, savings, investing, etc.). There are computer-based programs like EveryDollar.com, Mint, and others that can help with the task or you can download a free copy of our Budget Binder for a tangible copy. Once you have determined how much is needed to pay your bills, debt minimum payments and future expenses (new tires for your car are not an emergency. It should be a planned automobile expense. After all, you know they are going to wear out, plan for it), then you can plan your debt elimination strategy.
List your debts, smallest to largest, irrespective of the interest rate. Once you have allocated the minimum payment on each account, add any additional dollars available to the smallest bill. Continue that process until that debt is gone. The next step is extremely important. You take the extra money you were adding to that smallest bill, plus the amount of the regular payment and add it to the minimum payment you have been making on the next largest bill. This process is called a Debt Snowball.
What happens if I experience an emergency during my debt reduction process? 1) I use my Emergency Fund to pay for the emergency (incurring no additional debt or interest charges), 2) I stop my extra debt reduction and divert the payments to the Emergency Fund until it is returned to the $1000 level, and 3) I return to my debt reduction Snowball as soon as possible. This process continues until all my debts are gone. The last likely being your home mortgage.
Studies show that 80% of Americans have debt and 189 Million people in the U.S. have credit cards. It has to be a conscious decision not to create debt. Postpone that home purchase until you have accumulated a larger down-payment and can afford a 15-year mortgage, instead of a 30-year obligation.
Vacation on “Porch-Ville” for a few years until those debts are gone. Drive that older car until you’ve saved for a newer one, and then buy a gently used vehicle instead of a brand new one, saving all that high front-end depreciation. Dining out can be very expensive, so limit that too. All the monies you save can go toward reducing that debt.
Earlier I said that 10 Million people worldwide have been infected with the coronavirus, well, 189 Million in the U.S. have credit cards carrying an average balance of $8300. 8 of the next 10 people you will meet are in debt. I submit to you that is a “Financial Wellness Pandemic”, much larger than the coronavirus.
So, if you are one of those 8 people in debt, I encourage you to take the steps to get your “Financial Health” in order (and be sure to have plenty of hand sanitizer and toilet paper).
Author: Don Waite, the Financial Wellness Coordinator, and a Financial Advisor with Duncan Financial Group.
*(Bankrate Survey, Jan. 2020).