6 ways to stress-test your finances for unexpected setbacks

Mar 4, 2016 at 6:00 p.m. ET
Image: David Sacks/Getty Images

Could your personal finances handle a major setback? A sudden or unexpected event, such as a job loss, major expense or sick parent, could make you vulnerable. You may temporarily lose sight of the big picture and become reactive or act hastily when what you really need is to pause, reflect and take stock.  Most of us can recover. It depends on the event, our age and personal circumstance.

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As an example, John, a major executive in a midsize firm in a big city, lost his job when his area of expertise became redundant as the company embraced a new strategic direction. Once a big fish in a little pond, he suddenly became a little fish in a big pond midway through his career. But he was lucky. He landed on his feet because he received a generous severance package and was reemployed quickly. His ego took a bit of a bruising, but financially he was OK. This is not always the case.

Susan graduated from college and started an entry-level job in her field. Sadly, her health took a turn and she was forced to leave her job. She was not entitled to any health benefits or an extended leave of absence. In short, she had to move home for support.

Managing a big change in life can be daunting. That’s why we need a clear understanding of our financial situation. It can’t be fuzzy. Banks, for example, regularly conduct stress tests to identify areas of vulnerability. Testing allows for preventative planning to avoid systemic breakdowns or unrecoverable losses.

Stress-testing your financial situation is a good habit to get into because it gives you a quick snapshot of your financial health. Sudden changes in the market —  such as the recent oil and gas sector weakness, Canadian dollar volatility, rising interest rates and escalating cost of living — all impact our lives. Some of us may have changed our vacation plans, pushed back retirement or reconsidered a major purchase.

When things are uncertain, it’s smart to know where you stand. Take the time to do a quick stress test on your personal finances.

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1. Calculate your net worth

Figure out how much you have and subtract how much you owe. Knowing how much you are worth is a good way to assess your current financial situation. Is it positive or negative? What needs changing or adjusting? How are your debt levels?

2. Check in with your adviser

Has your risk tolerance changed? Do you have sufficient liquid assets that could easily be converted to cash if needed? If an adviser manages your investments, reach out to them for an update. Do they really understand you? If they haven’t called you lately, now might be a good time to reexamine the relationship.

3. Assess your cash flow

This is a straightforward calculation. Determine how much money comes in and subtract how much money goes out. If you find yourself close to a zero balance, you may be vulnerable. Check in with your lifestyle choices. Many of us love our luxury items. Subtle lifestyle changes could easily add more to your bottom line.

4. Examine your credit score

It’s easy to miss paying a bill on time. It’s also a big wake-up call when you've done all the right things and saved money for a down payment on a home, only to find you can’t get a mortgage because of a bad credit rating for bill payment lapses. Check in with your credit score today at Equifax. Automate all bill payments.

5. Build an emergency cushion

A sudden job loss or change in your income or employment may make you vulnerable. Maternity-leave benefits may not cover your overhead. Severance packages and UI benefits eventually run out. Make sure you have some emergency funds in place that are easy to access.

6. Confirm your insurance

Long-term disability insurance is essential, especially if you are self-employed. These plans help to replace or offset lost income due to an illness. Review all your insurance policies, so you're not caught off-guard.

Take action today to ensure you are set up to weather any type of setback. It’s that simple.

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