If the past two years has taught us anything, it’s that unexpected (even inconceivable) events happen and can have profoundly negative effects on our financial lives. While none of us thought a few years ago that we’d be navigating multiple challenges that come with a global pandemic, the truth is that unexpected events big and small are a regular part of life. And, preparing financially for unexpected expenses is key.
From a personal finance point of view, we all need to understand how important it is to prepare for potentially unexpected costs. Failing to do so can imperil your ability to reach your near- and long-term financial goals.
“Financial planning is not only planning for retirement. It is also looking at risks that could derail financial goals that are important to clients,” says Randa Hoffman, a financial planner with Radiant Wealth Planning in Newport Beach, CA. “We ideally want to mitigate as much of the risk as financially possible.”
The first step toward mitigating the risks of unexpected expenses is to understand the universe of unknown events that could impact your financial health. The second step is to prepare as best you can.
What Costs Can Disrupt My Budget?
At first blush, some expenses sound small. “These are the little expenses that pop up when life happens,” says Alexander Collins, a senior partner with Quantified Financial Partners in Kirkland, WA, “whether this is the unexpected art project for one of the kids; a flat tire, dead battery or other minor car issue; or paying for copays for a trip to the doctor.”
But for many of us, these expenses can negatively affect our budget. That’s because about 40% of Americans would struggle to scrape together $400 to pay an unexpected bill or emergency expense, and a survey by AAA found that one in three drivers couldn’t pay for a surprise car repair bill.
While over the course of the pandemic Americans accrued excess savings as a result of stimulus cash infusions, savings accounts for many have significantly decreased. It’s important to take proper steps to save funds that can help cover additional emergency expenses that may come up in the future.
What are Unexpected Expenses?
There are many different types of unexpected expenses that may come up.
We all have monthly bills for which we budget and pay, which means we’re expecting to pay them. We all have to pay energy bills, housing costs and more. Expected means that they’re predictable and we can plan for them.
And then there are the unexpected expenses that come up. Here are a few examples of expenses that may be considered as unexpected or emergency expenses:
• Medical emergencies
• Pet care emergencies
• Home repairs
• Auto repairs
Having a savings account or emergency fund that can cover those costs that we can’t anticipate can alleviate stress, help with financial planning and ensure that those planned expenses stay on track with monthly budgets.
We certainly can’t plan for everything, but we can be prepared.
3 Tips to Plan for Unexpected Costs
Dan Herron, a principal with Elemental Wealth Advisors in San Luis Obispo, CA, says that COVID-19 has been a “stress test” for people’s finances. “It has proven to display the weaknesses in people’s financial plans and pointed out the areas that can be improved,” he says.One critical change we can all make is to recognize that unexpected costs big and small will arise and then take actions like the following to prepare for them:
1
Establish an Emergency Fund: Before COVID-19 emerged, Herron says the typical emergency fund was designed to cover a family’s expenses for three to six months. “When the dust settles, we are looking for six months to one year of emergency savings to be ready in case another pandemic or big life-changing event occurs,” he says.
Financial experts differ in how much they believe people should save for unexpected expenses, but most advocate making automatic contributions each paycheck into distinct accounts dedicated only for emergencies. That way the savings will accumulate without any necessary action on your part, and the money won’t blend in with the other accounts you use to pay your bills.
2
Take Out an Insurance Policy: A critical piece in any plan to cover unexpected costs is to have adequate insurance, including home, car, health and life insurance. For instance, according to eHealth, the average cost of a health insurance policy is $462 for a single person and $1,437 for a family of four.
While this is hardly an insignificant expense, it is far more manageable than having to come up with tens of thousands of dollars to cover an ER visit or a serious disease like cancer. Life insurance is particularly important for those with loved ones who depend on their income. “The majority of life insurance death benefit payouts can be used for anything necessary. Besides the loss of income that often comes with an unexpected death are the final expenses in someone’s life, including funeral costs and final bills,” says Jake Irving, the owner of ClueRx in Portland, OR.
3
Budget and Use Credit: In an emergency, credit cards can help cover unexpected expenses if you don’t have enough savings to cover your bills. But you can also use credit to understand your spending habits before an emergency occurs. Responsible use of credit cards can help in budgeting because reviewing monthly statements helps pinpoint expenses that can be trimmed in order to save money for unexpected costs.
It’s a strange thing to say, but you can definitely expect unexpected costs to pop up in your life. And you won’t be able to prepare for them after the fact, so now is the time to build your emergency plan so you’re ready for next time.
A former editor at Los Angeles magazine, Chris Warren has had work appear in publications ranging from Institutional Investor and Forbes to National Geographic Traveler, Oxford American and Greentech Media.
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