How to prepare for financial changes

 
Incarnation (#100) By Mark Ryden
We don't always get to prepare for major financial changes, things like a job loss or an unexpected medical expense can really throw us off of our game. In these situations it's best to have an emergency fund to fall back on. But occasionally in life we have changes that we can prepare for. Sometimes that might be moving to a new house, having children, quitting a job to go back to school, or perhaps my favorite one to dream about - retirement.

So how do we prepare for an event like this. How do we know that we are making a responsible decision?

Budget

Before you know what the future holds you need to know what's in your past. Some people don't know where their money is going at all, for this I prefer to use Mint. It's a budget tracking tool that shows you where all of your money goes. It takes a little bit to get all of your accounts linked up but once you have everything there it's really easy to navigate and see what you're spending your money on. There's also an app called You Need A Budget (YNAB) that is very popular for budgeting, some people say that YNAB is more proactive with your budget than reactive like Mint where you just see where your money went after you spent it. I've never used YNAB, the first month of it is free but after that there's a fee so I've never been that interested in it, but I do hear positive things.

Knowing where your money goes is a huge first step. If you find that you're spending $1500 a month on food for one person then you could probably tighten that up, because $50 per day is probably more than you really need.

Simulate Your New Expenses

Once you know what you're doing with your money, hopefully you found a few places to tighten things up while you were there. The next step should be to see if you could get by with your new expenses (or perhaps lower income). If you have enough time to implement this test run before it's actually time to do it you should try actually setting aside the money that would be going to this new expense. I would recommend putting our "simulation" money some place different than your regular checking account, that way you don't get tempted to spend it something when we are pretending that money doesn't exist. If you have a separate savings account for an emergency fund then this might be a good time to pad that account a little. If you don't have a separate account for this then this would probably be a good time to start that emergency fund. :-)

If you know you'll have $300 less income during this change then set aside $300 each month in the simulation. Or if you'll be moving to a bigger home because of a new child and rent will increase by $800 then set aside that much.

The two major keys are to accurately project how much you will really be spending (this could be hard with a new baby) and to pretend that this money does not exist anymore. If you can make it through the month with ease then you know that your new budget will work. Personally I like to error on the side of caution so I personally recommend to overestimate your costs. The worst case scenario is that you end up with extra money which is always a good problem.

What to do if your simulation fails

If you can't get by with your simulation not all hope is lost, the first thing you should do is re-evaluate your projected expenses. If you're leaving a job then this step probably won't work for you, you will know exactly how much your paycheck was and can do the math. But if you're projected expenses for a new baby are $400 per month (I have no idea what kids cost) then perhaps consider using cloth diapers and knock off $40 a month from your projected costs. If you're planning to move to a bigger house, then perhaps you should move to a "slightly" bigger house, or a house in a cheaper neighborhood.

The second step would be to look at your regular budget you have now. Are their things you can cut back on now. Some people can't get rid of their Starbucks habit but perhaps bringing lunch to work instead of going out will save you a lot. I know it did for me. You could also cut cable or find a cheaper cell phone plan. There's usually lots of things that people can cut back on. And it's not because they can't, it's because they just don't want to. I'm certain that not everything in your current life is a need, you just need to figure out which things are more important, the change you want to simulate, or your life the exact way it is now.

Have you ever prepared for a financial change? What did you do to prepare?

13 comments:

  1. I like the 'simulation' idea. I know I should have probably thought about it but I never 'played' at having less money. My preparation involved spreadsheets and research. Well, we are here to learn :).

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    1. Spreadsheets and planning can work just as well. I think anyone nearing any major financial changes should try to plan something out at the very least.

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  2. The simulation model is a great idea for planned changes to finances. I'll probably do something similar to this when I near retirement - live off the equivalent of my retirement income. It's sort of like a practice run!

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    1. exactly, I'm definitely doing a practice run before I pull the trigger on something as big as retirement!

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  3. My wife and I are getting our feet wet with the simulation model. We want one of us to stay home when we have kids, so right now, we are saving the majority of our income. It is teaching us to live on less each month and we are realizing there is a lot of stuff we don't need. Plus, it is boosting our savings big time so we will have a bigger cushion to fall back on should we need to.

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    1. Yeah, the two fold idea that 1, you are testing out a new change, and 2 while you test it out you save a TON more for a buffer just in case is great.

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  4. My husband and I are in the simulation stage as well -- simulating retirement life. We live on a written budget (and have for years) and have identified which budget items will disappear once we retire and which will remain. We make a point of living within our means on the "will remain" bits.

    It's not a foolproof solution of course, as we'll have some new expenses in retirement too (medical insurance, for example). We created a "retirement spending plan" that covers all of 'em, and then ran a simulation on a retirement calculator to be sure our assets would last long enough at that level. It was enough of an effort that I created a Retirement Readiness Assessment (offered on my site) to help other readers work through the simulations.

    Good for you for planning ahead and thinking through where the challenges might be. I'd say it puts you ahead of most!

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    1. Yeah, it's hard to simulate changes that haven't happened yet. Health coverage could vary quite a bit from what you plan and what actually happens. But at the same time your expenses could drop in other ways that you might not exactly expect either such as commuting and wear and tear on vehicles might be significantly less.

      I think that as long as you are not going in blind you are at least a little more prepared.

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  5. Planning ahead and giving genuine, detailed thought to what the new circumstances might be, can go a long way to helping prepare for changes. I do like the simulation idea!

    Now, sometimes changes are intentional - and that's where it's easier (and should be expected) to plan. However, sometimes changes are unexpected. This is where I think we always need to be flexible and keep our spending habits open to handle sudden changes that happen to us (job loss, illness, etc) that we didn't really foresee.

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    1. Flexibility is one of the most valuable things out there. If you can adjust and adapt to situations instead of being backed into a corner with no choices then you will probably be happier in general. Even if all of your situations are not ideal because of a crappy situation you will still probably be better off.

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  6. Going beyond what you mentioned, I cannot help but think of people who have relied on their partner's finances and then end up in a divorce or even a partner dies. Many people have no idea what is going on with their household finances when they are not the primary "breadwinners" . I remember my mom telling me once to make sure I know what's going on in my house financially. To be honest, money scares me and I tend to turn a blind eye beyond saving it. Only recently have I been taking a bigger interest in what we have collectively. To this day it's hard for me to say "our money" so it's hard to ask about it because I don't feel like it is mine. It's hard to think something is yours that you didn't work to earn. The fact that a part of his retirement is mine is mind boggling. It's funny to me that having a government piece of paper is supposed to change whose money it is and almost magically gives it to both people. I am rambling, but I am sure you get the point / question.

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    1. Rags2Riches,

      Most households are a team. The way that I view marriage is that, it's you and me, as a team, forever. But financial planning can be very difficult when peoples goals aren't the same, for example, I am working towards early financial independence. It's something that's taken me a few years to get on a path that I view sustainable. Most people probably wouldn't have the discipline to save over 50% of their income but I do. I think that whenever I get into a relationship with someone new this will be a topic that most people will have a hard time committing to. I don't expect them to be able to match me percentage wise but at the same time I don't know if I would feel comfortable "retiring" early only to watch them work for another few decades.

      This is where my "team" aspect comes in, I would probably work longer to help push our savings to a point where we could either retire together (still early) or still work, but at a less stressful and more enjoyable job since money wouldn't be as much of an issue.

      If you've never had a discussion of what retirement might be like together that's probably pretty normal, but it's also something that should probably be addressed. Would you retire together or do you plan to save individually? Couples have to come up with something that makes sense to them. Some people say that they couldn't imagine not working, if that's the case then perhaps one person would continue to work and the other can retire early and take care of more of the household duties to so that everyone's life is more comfortable in one way or another.

      Anyways, if you don't know what your "teams" plan is, then you will have a hard time planning for it. Perhaps the easiest way to start off the conversation is to just ask what your current financial goals are for the short and long term. Are you planning on buying a house or car? If so what's the timeframe and how much do you think you need verses how much is saved. Then ask about retirement plans, you might not have a goal or a year in mind, but you can probably get a glimpse as to how much you have saved currently.

      -Zee

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  7. Planning is the key to be prepared for financial changes and this is a lesson which everyone has to learn before it gets too late and especially for their retirement.

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