A disturbing article from the Wall Street Journal reports that Nearly Half of Americans Are ‘Financially Fragile’, which is defined in the article as households who “definitely or probably couldn’t come up with $2,000 in 30 days.”
The $2,000 figure was chosen because it’s roughly the cost of “an unanticipated major car repair, a large co-payment on a medical expense, legal expenses, or a home repair”—in other words, expenses that are hardly out of the question for a typical household.
According to the article 46.5% of all respondents are living very close to the financial edge—in other words, nearly half of America. And it’s one of the worst rates in the world—in Italy for example, the rate is only 20%. But it gets even worse; an additional 25.1% of U.S. respondents answered that they were “probably able” to come up with $2,000—meaning that they aren’t entirely sure.
That’s a sad state of affairs no matter how you interpret it.
How should we respond to this information? By making certain we don’t fall into the same category!
How do we become financially fragile?
The first way to avoid financial fragility is to understand how you can get into that position in the first place. The rocky state of the economy in the past few years has certainly pushed many household into some level of financial distress, and that’s not entirely within our control. However, there are other lifestyle factors that have contributed that are very much within our control:
- Living above your means. This is the major cause of financial problems in many households. The only way to accumulate savings is to live beneath your means and bank the difference. Not enough people do that these days.
- Perpetual “crisis management” toward finances. There’s no preparation for potential problems and each one that comes up creates a crisis that’s met with eleventh hour solutions. A similar lack of preparedness greets each new crisis.
- Excessive optimism. America is nothing if not an optimistic country. We assume tomorrow will always be better, but the Achilles heal of that sunny view is that it can leave us unprepared when our rosy assumptions don’t pan out.
- No emphasis on savings. We live in a consumer driven economy where the name of the game for many is simply to live well. That lifestyle can leave little room or even perceived need for savings.
- Using debt as savings. Some of the people considered to be financially fragile have substantial assets, but none of it is liquid. Home equity and retirement plans may be excellent asset accumulation vehicles, but they aren’t cash in a crisis. Liquidity is important no matter what your financial status in life may be
How to stop being financially fragile
Start a crash savings program.
Commit to getting some money into a savings account within a short space of time—30, 60 or 90 days—what ever your capabilities will allow.
Sell a bunch of little things, sell a couple of not so little things (car, jet ski, motorcycle or what ever you can), take a part time job for a while, bank a bonus or an income tax refund—do what ever it takes to raise some cash in a hurry.
Elevate the effort to the level of a crisis itself; if you have no savings of any kind then you already are in crisis. Since just getting started is the biggest obstacle to building savings, quick action and results will be critical.
Bring your cost of living down below your income.
If your crash savings program enables you to put a couple thousand dollars into your savings account quickly, you can take this step more gradually. Set workable goals—lower your expenses just 5% for the first three months, then increase it to 10% for the next three. Be sure to bank the difference and in doing so, you’ll gradually create a savings habit—you want to make saving a part of your financial lifestyle.
For most people, building savings while paying off debt will be too much to handle at once. Better to make saving the priority so you can have a ready cash reserve that will make borrowing unnecessary in the future.
In the meantime, just make the scheduled payments on your loans and don’t add any new debt. You’ll be in a better position to pay off your debts once you have a fat savings cushion.
Simply learning to live without borrowing can increase the importance of savings.
Have different types of savings.
An emergency fund should be established for its true purpose—which to sit and do nothing but collect interest until it’s needed in a crisis. But that’s not enough. There needs to be a second level of savings for large, predictable expenses, such as the replacement of a car or the upcoming family vacation.
Investments should make up the third tier—retirement assets and other long term investments. In this way you’ll be preparing for short, medium and long term financial needs which will enable you to better anticipate financial problems, rather than just reacting to them as they happen.
As with all other types of change in life, the key is to take action and to continue until the new effort become blended with the rest of your life. The sooner that’s done, the sooner you’ll be off the financial edge and in position to move onto something better.