Loss of a loved one in the family causes emotional grief that takes a long time to heal. Financial grief is no different. This refers to the stress you undergo due to life-changing development that has a negative effect on your cash flows. With poor economic performance, it is important that you prepare yourself against such events. In this article, we define financial grief. We then suggest measures to moderate your pain during such period, if you suffer one.

Financial grief

You are used to a certain standard of living. Any threat to that standard of living can cause stress. Financial grief is an emotional state you will face when you are forced to lower your standard of living due to negative events that affect the two assets you possess — your human capital and your investment capital.

Human capital is the present value of all your income flows during your working life. Financial grief due to human capital may result from loss of employment or just worrying about loss of employment. This event has become a reality in the current economic scenario, especially for people in the entry-level and middle-level positions in companies. Pay-cut is another financial grief based on human capital. While better than loss of employment, pay-cut hurts as it forces you to cut back on your household expenditure, thereby, lowering your standard of living. Sometimes, pay-cut could be in the form of lowering of long-term benefits such as health-care and retirement benefits.

Financial grief based on investment capital results due to sharp loss in investments and decreased value of self-occupied house. The increased volatility of stocks and uncertainty about interest rate changes only lends credence to the possibility of such a grief.

Moderating grief

The question: If you face one or more such events, how can you moderate or lower your financial grief? The answer depends on how susceptible you are to suffering financial grief.

As a first step to moderating your financial grief, you should create large protective asset. In our wealth mapping process, protective asset is the process set up to protect your basic standard of living. To do so, you should create sufficient emergency funds. If you have a high risk of suffering from financial grief, you should gradually build an emergency fund that is 12 times your monthly expenses. At this point in time, you may feel that our suggested size of emergency fund appears too large.

We agree. In good times, it is, indeed, large. But emergency fund is not for good times. Such a fund is set-up to take care of you during your financial grief.

Consider this. Your human-capital-based financial grief is high when you have lost your job and your skills cannot be easily redeployed in other sectors that are performing well. Likewise, your investment-capital- based financial grief is high when you are in the retirement risk zone (refer to this column dated August 19). In both these cases, a high level of emergency fund will help you moderate your financial grief. How?

If it is human-capital-based financial grief, you can depend on your large emergency fund to support your monthly expenses while you find a job. And in case of pay-cut, your large emergency fund will give you time to develop innovative ideas to generate additional income to bridge the gap.

The choice

Emergency fund will moderate temporary financial grief. Longer-term financial grief such as large decline in portfolio just before retirement cannot be moderated using emergency fund. Your choice will then be to delay your retirement.

This will enable you to postpone withdrawal from your portfolio to support your lifestyle expenses. Besides, significant proportion of your health care costs will be borne by your employer. The point is this: temporary or long-term, financial grief is stressful. Prepare yourself for it.

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

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