Are you prepared for life’s contingencies?

It is not difficult to plan investments when you have savings. But what if you do not save enough after paying for your regular household expenses? Or what if an adverse event affects your family’s finances permanently? In this article, we discuss how you should position your finances so that you are prepared to meet life’s challenges if you are forced to face one. This article is a sequel to the one on handling financial grief (refer to this column dated August 26, 2012).

Contingency plan

Being laid-off can hurt. But worse still, what if you (or your spouse) face permanent disability due to an accident? It is better to plan for such contingency now than feel sorry later. Or what if you are already finding it difficult to save enough to meet your life goals? Here are some questions that will help plan your finances better.

One, for those of you who are finding it difficult to save, can you reduce your non-discretionary expenses? By this, we mean monthly, quarterly or annual expenses such as your home maintenance, car loan or even house rentals.

Now, you may be wondering why we are suggesting that you reduce your non-discretionary instead of discretionary expenses. By discretionary, we mean your Saturday-night dinners, monthly movie expenses or even the not-so-frequent vacations. There are two reasons. One, you need to enjoy good things in life.

And yet have money to save for the future. And two, if you cut discretionary expenses now, you will have very limited room to downsize your household budget if you fall into bad times! On the other hand, if you moderate your non-discretionary expenses now and live within a budget, you can invest the amount saved. Importantly, you can cut on your gym fees or your vacation when you face tough times.

How should you shave-off your non-discretionary expenses? If your house rental is high, consider moving into a smaller apartment. Or if your car loan is hurting your savings potential, see if you can sell your car and look for alternative transportation.

Two, for families with two income earners, can you survive on a single income? This would apply to you if either you or your spouse has unstable income, though you are financially comfortable today. The uncertainty in earnings can be due to poor performance of your company, or because your business is passing through tough times.

In either case, you should be able to manage your household expenses with one income — the one that is more stable. Do not attempt to save the whole of the second income. You need to balance current lifestyle with future security of your family. Use at least 10 per cent of your second income on discretionary spending. Then, save the rest and invest through a systematic investment plan.

But what if you are the sole-income earner in your family? Then, ensure that your spouse is updated on his or her skills. In the event your income is adversely affected, your spouse then has a chance to re-enter the workforce.

Cutting down

It is important that you allocate money for splurging, even as you provide for life’s emergencies.

That is why you should consider reducing your non-discretionary expenses. In this regard, it is important that you take a loan which you can repay through single income, even if yours is a two-income family. That will give you cash-flow flexibility during uncertain times.

The objective is to reduce your emotional stress when an unforeseen circumstance changes your family’s lifestyle, perhaps, permanently. And do not forget to buy insurance to protect your basic lifestyle — disability, life and health-care insurance. Remember, these are non-discretionary expenses you should not comprise on!

(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investorlearning solutions. Feedback can be sent to >knowledge@thehindu.co.in)