Financial resilience is the ability to hold up when life throws you an inevitable financial curve. If this seems broad, it should. There are ramifications to financial events beyond mere dollars and cents.
Divorce, disability, job loss — they may seem unconnected financially, yet they share some common characteristics. All can bring financial shock, and all can bring stress and other physical or mental symptoms and challenges.
As the world continues to grapple with various complexities of the coronavirus, the importance of financial resilience is gaining renewed attention. Many people seem to be experiencing a lingering emotional hangover from the challenges imposed by this cataclysmic event.
It is not possible to completely insulate yourself from financial shock. It is possible, however, to prepare yourself for what could come at any time. No one wants calamity, but calamity still comes.
Financial shocks and setbacks affect both you and your money. To be prepared to handle shocks with resilience, you need to prepare yourself and prepare your wealth.
Being prepared, as an individual, for financial shock consists of three main components, your psychological capital, your financial literacy, and your human capital.
Your psychological capital consists of hope, efficacy, resilience, and optimism (aka HERO).
Hope is the process by which we believe we can set goals and attempt to meet those goals to change an existing situation. Efficacy is our belief in our own ability to create results. Resilience is our ability to bounce back from failure or adversity, and optimism is positive conviction about our future.
The attributes of psychological capital work together; it is easier, or at least more likely, that a hopeful, high efficacy, and resilient individual be optimistic. All these traits are learnable, and to a high degree, controllable. And there are resources that can help, from books and courses to life coaches and therapists.
The degree of an individual’s psychological capital will impact how they respond to financial shocks. Individuals with higher psychological capital will likely be less negatively affected by outside shocks.
Financial literacy is our knowledge of and ability to make use of the financial systems. Both components are necessary to be financially literate: Having knowledge of systems you cannot use would be useless; having use of systems without knowledge is potentially dangerous.
Financial literacy is controllable. The extent of a person’s knowledge of and ability to use the financial systems can be directly influenced by efforts to better these skill sets.
There are a plethora of resources, from books and podcasts to blogs and websites to formal courses and certificate or degree programs. In addition, there are various forms of professional assistance including financial coaches and financial advisors.
Having a high degree of financial literacy helps an individual separate the reality of a financial shock from its emotional charge. The reality is the nuts and bolts of the situation we have to deal with. Understanding the true financial magnitude of the shock reduces our likelihood of blowing it out of proportion or indulging in doom and gloom scenarios.
Human capital is your set of abilities, skills, knowledge, and other attributes that make you valuable in the marketplace. This has a direct bearing on your ability to deal with financial shocks with a high degree of resilience.
Higher degrees of human capital improve your marketability and increase your confidence that you can find a good outcome when faced with an employment challenge.
Human capital, like psychological capital and financial literacy, is something that individuals can choose to develop over time. There are vast opportunities for development and enhancing one’s value in the marketplace.
These three attributes work together; raising one will help in raising others or making it easier to raise them.
Prepare Your Wealth
Though financial literacy assures us of our knowledge and ability to use the financial systems, we often fall short on behavior — and that is where we make lasting change.
Preparing your wealth is making use of financial literacy to make your financial foundation better able to weather the storms of life. There are four foundational attributes that should be developed and two systems we should consider.
Have a Financial Plan
A financial plan does not need to be 300 pages, although it can be. Ninety-nine percent of what most people need can be spelled out on a single page. Once you do that, you can decide if you want to do more later.
A basic plan outlines your financial goals, where you stand in relation to those goals, and how you make changes to achieve them. This is a roadmap for your financial future and the first thing you will turn to in the event of a financial shock. It is, after all, what you have said is most important to you, financially.
Work a Budget
Many people dread the “B” word. No problem — let’s call it a spending plan.
This too does not need to be complex. It does need to list our sources of income as well as all of our committed expenses. It may or may not allocate discretionary expenses. In many cases, that isn’t necessary.
If you are living within your means and keeping on pace for your goals, it can be important to know all of your committed expenses; the other expenses are collectively your lifestyle and not as relevant on a day-to-day basis.
If you are not living within your means and not on track for your financial goals, then perhaps you might reconsider your reluctance to tackle this simple task.
Along with your financial plan, a budget is an invaluable resource when faced with a financial shock. It allows you to very quickly identify options, either for immediate or later use, that can be changed to affect a better outcome.
This is where you go when you have an unexpected large expense or an unexpected loss of income. Those are (not coincidentally) where financial shocks — large unexpected expenses or big reductions in income — come from.
We tend to suffer from a bias where we don’t expect bad things to happen to us. Sometimes we are wrong, as tough as that may be to admit. And sometimes bad things happen and we are swept up with the masses, not anything to do with us, but we still have a situation to deal with.
An emergency fund is a core defense against financial shock.
We should have adequate protection for those things we cannot afford to lose, such as our ability to earn an income. We do not need to be, nor is it financially prudent to be, overprotected, but having protection can mean increased financial resilience.
Many financial shocks are lessened by adequate protection.
A disability, loss of a loved one, and many other calamities are difficult to deal with; we do not need to add financial stress on top of them. The things we should make sure we are protected against are those that are more unlikely, but have a significant financial consequence.
Not having an extended warranty on your big-screen TV shouldn’t be life altering; not having adequate long-term disability insurance could be.
In addition to shoring up our financial foundations, there are two systems concepts we should pay attention to.
To the extent possible, we should automate our financial lives. Those who have automatic payments into their emergency funds are far more likely to have an adequate emergency fund.
Many people do not want to allocate the time to monitor their financial situations closely. Automation can greatly reduce that burden and help you maintain appropriate financial systems without the work of closely monitoring those systems on an ongoing basis.
Live Within Your Means
Living within your means doesn’t necessarily mean living frugally or with hardship. It simply means that you allocate your income such that you can pay all your expenses, including funding your long-term goals, on the money you make.
To live within your means, you need to make appropriate financial decisions based on your income and other resources. This typically means some trade-offs; very few people can do anything they desire to do. For most people, which vehicle they drive, for example, impacts their ability to fund their long-term goals, such as the education of their children.
Living within your means will naturally limit the debt you carry, which will help you secure financial resilience. It is normal to live within your means and have a mortgage and a car payment, but not a lot of consumer debt. High credit card balances and other forms of consumer debt are indicators of not living within your means.
Debt becomes a bigger problem when faced with financial shocks. Living within your means helps maintain your financial foundation to be resistant to financial shocks.
The Bottom Line
We all face various financial shocks from time to time. Some are relatively minor, such as a significant car repair we didn’t anticipate. Others are major, a significant uninsured medical event, loss of a job, or other major financial setback.
We all deal with things differently, and what causes major stress for one person may cause minor stress for another. But no matter what our individual makeup, we can further our financial resilience by how we prepare ourselves, both as individuals and by how we manage our money, to be better prepared for life’s inevitable shocks.