Or maybe true disaster strikes–and it’s crazy to assume it won’t. A tree falls through our roof in a windstorm. We can’t work for a few months due to injuries from a car accident. Can we cover this deluge of expenses, or will it send us scrambling for the plastic? Statistics suggest that a lot of us are letting our lenders foot a bigger portion of our bills. According to the Federal Reserve Board, $17.60 of every $100 the median 1998 family made went to debt payments–up 11 percent from 1989.
While credit cards are convenient tools, they can damage your personal finances. Why bother earning 11 percent on your stock portfolio if you’re paying 16 percent to 18 percent on your credit balances? Avoid running up a tab on your credit cards by preparing for two types of expenses–annual big-ticket items, such as family vacations, and unexpected setbacks, such as erupting furnaces and dot-com layoffs.
To save for those irregularly recurring expenditures, break them down to monthly expenses and save in advance. For example, if your auto-insurance bill comes due semiannually, divide the bill into six and put that amount aside each month. How much did you spend on summer vacation last year? Take that figure, divide it by 12 and add it to the monthly budget. Just a little planning can keep you from reaching for the plastic when the kids set off for summer camp.
Anticipating the unexpected is not as precise. You can assume that your biggest assets–your house, your car, your body–will need regular maintenance. To be prepared for appliance replacement, engine overhaul and plastic surgery, one strategy is to figure you’ll spend 1 per-cent to 3 percent of the value of the asset on maintenance and repair, depending on the asset’s age and condition. Again: divide your rough figure for annual upkeep by 12 and set that much aside each month.
What about more serious events, such as a disabling injury or sudden unemployment? We’re talking real emergencies that drive the unprepared into instant and seemingly inescapable debt. There are two aspects to emergency planning: insurance and the emergency fund.
Most of us have at least some life and property insurance. But disability insurance is too often ignored. Consider this: the average American 20-year-old is almost twice as likely to become at least temporarily disabled than he is to die before age 65. In short, disability insurance is more important than life insurance. If your employer does not offer either or both, or the coverage is thin, you can purchase policies from the major insurance carriers.
As for the emergency fund, the old saw is to save three to six months’ worth of living expenses to cover your costs while unemployed. However, that amount can be adjusted according to your other savings. These savings should be stashed in an account with healthy, predictable interest payments, like short-term certificates of deposit or a brokerage money-market fund–not the topsy-turvy stock market.
The bottom line: you don’t have to fall victim to the sinister underbelly of debt as long as you plan ahead.
