In the days, weeks and months following a major life event or catastrophic weather, people impacted may find themselves in immediate need for cash. Events of this magnitude might be something a rainy-day fund just can't cover.
From money for temporary shelter to funds to replace a damaged roof, there are often many expenses that pop up in the aftermath of a disaster that need to be paid before the first insurance reimbursement check comes in.
While you can't predict when or where a natural disaster will strike, you can plan ahead to have the liquidity to weather the storms when they hit, says Fred Rose, head of Credit and Liquidity Solutions at RBC Wealth Management-U.S.
One key to risk mitigation is knowing risk is always on the periphery. To protect yourself and your family, it's important to periodically reassess your financial situation and have a plan in place to give you the liquidity you need when you need it.
Preparing for the unexpected
“Whether you have a bad year in your business, a disaster strikes, you lose your job, your kids have something happen in their life where you've got to help them out … something unexpected can happen that will impact your cash flow over the next five years,” says Rose.
While you can never predict when those life events will happen, you can plan for them when they do. Often, the planning process begins with asking a lot of questions.
“How are your parents doing? Where are your kids at in their education? Are they going to college soon? Are they looking to buy their first home?” asks Eric Edstrom, director of cash management at RBC Wealth Management-U.S. “What's going on in your life?”
Preparation, says Edstrom, is about determining what percentage or cash level you feel is necessary to mitigate disruption during those unexpected life events, and then building that into your overall wealth plan.
Building an emergency fund
One of the most important steps you can take to mitigate financial risk is to start building an emergency fund early, suggests Angie O'Leary, head of Wealth Planning at RBC Wealth Management-U.S.
“If you're just coming out of college or if you're newly married, having that emergency fund is really important,” says O'Leary. “We advise having three-to-six months’ worth of your income banked.”
“You base everything off of expenses because generally, that's the lifestyle you have,” says Rose. For instance, if you typically spend money on higher-quality goods – like appliances – you will want to ensure you have enough cash on hand for replacing large-ticket items. So if your basement gets flooded and destroys the laundry room, you need to factor in the costs to repair and replace those items.
“Generally, look at the risk in your life — the risks to your cash flow and risks to your income — that should determine how much is in that oh-shoot bucket,” adds Rose.
The amount in your emergency fund may also depend on your family situation. If you have a spouse who is employed, plus children, you may wish to increase the amount you save in the event of an emergency.
Finding a savings account that maximizes interest for your emergency fund works, but O'Leary says the most important thing can be to ensure the money you need to access over the first three-to-six months of an emergency is liquid and available when you need it.
Establishing a line of credit
While many people look to their investment portfolio as a source of emergency funds, there are risks to tapping into those securities.
“A surprise sale in your portfolio (during an emergency) is generally an inopportune time,” says Rose. That's because if markets are high, this may lead to tax implications in the short and long term.
“A standby line of credit can bridge those gaps to avoid forcing the liquidation of your portfolio,” Rose says.
A line of credit could also be an option for investors who know they're going to have major unfunded costs over the next 24 months.
“If I know I'm going to have a big tax bill due or if I know I need to replace the roof on my house, I need to be baking that in [to the budget],” says Rose. “I might want to have a standby line of credit for that.”
O'Leary typically recommends having a secured equity line — whether that be against your home or your taxable portfolios and investment accounts — before going into retirement, when your income is lower and opening a line of credit could become more challenging.
Not only can a secured line help give you peace of mind, but it can also be used in the immediate aftermath of a disaster.
“We don't want clients to feel like they have to sell stock in a down market to fund their retirement needs,” O’Leary says. “That really has a large impact on their long-term retirement planning, especially early on.”
It all comes down to having a plan for liquidity in place and sticking to it.
“If you can make that saving automatic to begin with, that's really a nice way to get used to not spending that money,” says O'Leary. “Job one is to make sure you know how you're going to fund your emergencies.”
Securities-based loans involve special risks and are not suitable for everyone. You should review the provisions of any agreement and related disclosures, and consult with your own independent tax and legal advisors about any questions you have prior to using securities-based loans or lines of credit. Additional restrictions may apply.
RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC.