In the personal finance and financial independence space, we talk a lot about risk. Risk of a market crash. Risk of another 2008 type recession that cuts portfolios by 50%. The sequence of returns risk that can kill the 4% rule. We even have some quotes on deck from the investing greats on stomaching the risk the markets bring:
“If you have trouble imagining a 20% loss in the stock market, you shouldn’t be in stocks.” Jack Bogle (RIP 🙁 )
“You shouldn’t own common stocks if a 50% decrease in their value in a short period of time would cause you acute distress.” – Warren Buffet
“You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready – you won’t do well in the markets. If you go to Minnesota in January, you should know that it’s gonna be cold. You don’t panic when the thermometer falls below zero.” – Peter Lynch
Yes, Mr. Lynch. Minnesota does get cold in January.
While the markets took a short-lived downturn at the end of 2018, I started seeing all these posts and titles about the longest bull market on record coming to a close. The bears were taking over and the current state of our economy compared to the 2008 recession. People started to relive those years and how they weathered the storm financially (which is great reading for anyone who hasn’t experienced it BTW).
Are we headed to a recession? Or a bear market? Sure, eventually they both will happen. But we are missing a bunch of key details:
- What will cause it
- When it will happen
- How long it will last
More importantly, what part of the financial independence phase are you in when it happens.
When I was reading through all the stories and recaps, the main issue wasn’t that their investment accounts took a bath. Sure, if you were retired or near it, that would be a major issue, but for me (and I am assuming everyone else in the accumulation phase) the market bump shouldn’t keep you up at night. Other things should.
Ignore Market Bumps, Protect your C.F, E.F, and D.J. instead
We are talking about protecting your:
- Cash Flow
- Emergency Fund
- Day Job
I think about it this way, if our net worth gets cut in half this year, we have TIME to figure out a solution. It sucks, but you aren’t dealing with immediate needs. I spent a lot more time thinking about
- What is our cash flow situation (both in and out)
- Do we have enough in our emergency fund
- How secure are our jobs
Protect Your Cash Flow
“What is our cash flow situation (both in and out)”
This is a two-way street. How much are you taking in (and from how many different sources) and how much is going out. I honestly think the latter is just as important especially in the context of this post.
Think about your debt obligations
A lot of times when we talk reducing spending it is on the little things, coffee, lunch, gadgets, clothes, etc. They can certainly add up, but if you had a financial emergency you can stop that spending the same day with a little (now mandatory) discipline. Your mortgage, cars, and student loans are harder to defer and can eat up a significantly larger portion of your income (or can drain an emergency fund a lot faster).
We put a lot of effort into reducing our debt, and freeing up the cash flow is great. It will be even more important if our income is strained.
Have a List of Services you can cancel
Have a plan in place of what you can cut out to extend the life of your emergency fund. I have all of our recurring expenses listed out so I can quickly go to it and cut anything that isn’t necessary.
Multiple sources of income
This is where we need the most work. Outside of dividends, that doesn’t cover all that much right now, we don’t have enough sources of income. Each source of income becomes less important as more mature. Takes a long time and isn’t easy, but something to be consistently thinking about.
We will look at the main source of income (day job) a few sections down.
Protect Your Emergency Fund
“Do we have enough in our emergency fund”
Given you have one. If you don’t that is where you should start. Start stealing $20 from yourself every paycheck and ramp it up slowly to build up at least a few months of expenses. Personally, I think everyone should have AT LEAST their health insurance deductible on hand, in cash, to cover a medical emergency without pillaging their investment accounts.
I initially thought emergency funds were boring, but have completely changed my tune towards them. Not only do they provide a good excuse to skip out on minor insurance coverages, a few months of expenses made me feel better while I was reading stories of how people weathered the last recession in 2008.
We have a multi-layered emergency fund approach. 3-month cash buffer, cut expenses, brokerage account, and Roth IRAs if it got really ugly.
Once you have it in place, protect it. That means three things:
Don’t raid it for a non-emergency
You can define this however you want, but I think if you are honest with yourself you can put the line in a pretty good spot. I have found setting a minimum emergency limit helpful. We can absorb a few hundred dollars in unexpected costs by making a few cuts elsewhere in a month without tapping into our emergency fund. If a few stack up in a 1-2 month span we pull what we can’t cover.
Replenish it when you use it
Think of your emergency fund as a loan, that you need to pay back. It doesn’t need to be a lump sum payment, but replenish so you are prepared for the next one.
Safeguard it from loss
Some people keep their emergency fund invested, which is definitely on the riskier side of the equation. I don’t think people who are still building their account should do this, but if you have a substantial amount set aside I think it can be a good strategy. Keep enough to cover your medical deductibles on hand just in case you have an immediate need.
Protect Your Day Job
“How secure are our jobs?”
I broke this out from cash flow because for the majority of American families, it is a significant (if not only) source of income and also an affordable source of health coverage. Our dependency on our income from day jobs is the biggest risk we have as a family right now.
Keep tabs on your companies performance
Pretty easy if you are a publicly traded company, you can see the performance every quarter and get remarks from the CEO on the companies outlook. There are also a lot of people tracking your stock price and doing their due-diligence comparing you against the sector. Other things to keep an eye on:
- Are you still hiring and promoting
- Is your top line growing, or are you having to increase margins by cutting costs
- Have other teams or companies in your industry been hit by layoffs
Look at your function/role objectively
Everyone thinks they are safe until they aren’t. When the bottom line is threatened, companies start cutting costs and few are loyal.
Questions that go through my mind:
- Am I on a product or team that is profitable
- Can my job be outsourced
- What is my performance/track record
- How do I compare to my peers
Keep your options open
The farther I go into the corporate world, the more weight I put on building and maintaining a network. 90% of the people I know find jobs through connections at previous employers or friends. Feed that network, build favors and relationships you can leverage if you need to.
I haven’t been the best at this, but keeping LinkedIn and resumes up to date is important.
If there are a ton of red flags when you go through these sections, get proactive and start searching for your next job. The best time to look is when you are already employed.