Preparing for a Financial Disaster

May 12, 2011
Setu Mazumdar, MD

I guess it's natural for me to think about disasters since I trained in emergency medicine. I've seen so many examples of people who've suffered tragic, and expensive, events for which they weren't prepared. So it got me thinking about how to go about creating your own financial disaster plan.

I guess it's natural for me to think about disasters since I trained in emergency medicine. I've seen so many examples of people who've suffered tragic, and expensive, events for which they weren't prepared.

So it got me thinking about how to go about creating your own financial disaster plan.

What you need to do first is to make sure you have enough liquid assets to get you through immediate financial emergencies -- your house burning down, a death in the family, a car accident causing an extensive time in rehab.

So what do I mean by liquid assets? These are assets that you can sell quickly and not lose value. So while stocks are usually assets you could sell quickly, the fact that they fluctuate so much means that they don't meet the definition of liquid that you should use for emergency assets.

I know people who are making mid-six-figure incomes who don't have enough liquid assets to get them through times when they need them.

So what assets provide liquidity for you?

Generally the following should be used for financial emergencies (from highest liquidity to lowest liquidity):

Cash:

• Short term CDs (maturing less than 6 months)

• Money market accounts

• Money market mutual funds

• Ultra short term bond funds

What investment vehicle you use for you liquid emergency fund depends on several factors. The first is psychological reassurance. The less risk tolerant you are, the more savings you should keep in cash. Also, the greater your obligations -- monthly spending -- the greater the amount of cash you need to save. And finally interest rates (yields) matter. If you can have a big boost in yield with minimal incremental risk, then moving further down the list makes sense for some people.

To learn more about liquid assets, I suggest you read this.

This week’s financial prescription: Get started on your own financial disaster plan.