The Three D’s: Building A Strong Financial House

Ask any child about the lesson they learned from the ubiquitous fable “The Three Little Pigs” and they’ll invariably tell you, “build a strong house!” While that may seem obvious to most of us on a literal level, we often neglect to heed this advice on a metaphorical one. Indeed, while we no longer fear the Big Bad Wolf and his machinations, the lupine specter emerges in the form of the contingencies of life that affect our financial well-being.

The Strong Foundation of Insurance

Building a financial plan is tantamount to building a financial house, and a strong foundation is key to withstanding the huffing and puffing of life’s uncertainties. When building a strong and secure financial home, having the right insurance is the solid foundation. Without it, you’ve essentially built a house of sticks and straw. 

The Three D’s

So, this begs the question: how much insurance do I need? What do I need if something happens to me and I can’t earn an income? Perhaps the best answer to these questions comes in the form of a mnemonic device: The Three D’s.

Debt

If you pass away or are unable to work, you’ll want your debt to be paid off. This means having enough insurance to pay off the amount of debt owing and in the scenario that you can’t work, you’ll want insurance to cover the costs of the debt in order to continue to make the periodic payments.

Dependance

Insurance needs tend to start to become more of an issue when you get married, as often your partner may be a dependent, partnered to your income. Further to this, if you start to have children, they will become dependent on your income. Those two types of dependants will mean you should have something to cover the “what if’s” of life. For example, if you’re not working, the proper insurance can ensure that a lump sum of money comes in to help cover their dependent needs.

Death-Related Taxes

For those with a sizeable nest egg, death-related taxes are something to give serious thought to. Under our current income tax act, we are deemed to dispose of everything we own when we pass away–that doesn’t create any negative tax consequences when we give it to our spouse or partner, but the moment we pass it on to our children, or others such as nieces, nephews or even charities, there is a deemed disposition on any taxes that haven’t been paid. Therefore, it behooves those who want to pass on their nest eggs to see how insurance can help fund their death-related taxes or reduce the bill.

Solid Foundations

At the end of the day, it’s all about building a strong financial edifice that is resistant to the winds of chance and change. Just like the Three Little Pigs, you’ll want to build that foundation out of solid brick!

My general advice is not too different from the advice I give to anyone who is concerned with their future financial stability. The truth is that the future is never certain. Unforeseen layoffs, health issues and, yes, recessions, are all but a few possibilities. The good news is that most people who prepare for the future not only survive these financial contingencies, but many end up thriving. In short, the best way to weather any financial uncertainty is to be prepared.

The most common concerns many of my clients express as a result of a potential recession are:

1. What happens if I experience a potential drop in the value of my investments?
2. What happens if I lose income due to a reduction in hours, or layoff?

It is important to fully understand someone’s source of financial stress, and whether it is investment value only, or something greater such as financial instability.  To do a proper assessment, it’s important for a client to give me a financial snapshot of where they are now to determine more accurately how recessionary movements may impact them. An accurate assessment will result in a financial plan that will help one feel as good as one can about the future. Let’s be honest, no one likes negative surprises. But it’s best to have a plan for the worst-case scenario so that we can stay focused on growth when results are not the worst!

Risk Assessment

For those worried about stock equities dropping in value as a result of a recession, I would recommend assessing your risk tolerance with your financial advisor. It’s important to discuss how much of a loss you are comfortable in terms of both percentage and total dollars, and how long you are willing to wait timeframe-wise to see a recovery.  It is best to discuss this now with your advisor while your risk concerns are heightened, as a prior version of your risk tolerance may suggest you are a long-term investor who is very tolerant to market downturns.  That may not be accurate today, nor should your fear today result in divesting everything you own in investments.  Strike a balance between reasonable growth and downside protection.

Build Up Your Emergency Fund 

If the recessionary concern is more than just market value of investments, then the first thing I would recommend is identifying or establishing your emergency fund.  This fund will provide cash flow in the event a recessionary layoff prevents you or your family from earning income, or it provides cashflows for retirement or vacation needs so that existing investments can work their way through the recessionary and rebound periods. The optimal emergency fund is often cited as a minimum of 3 months income and a maximum of 6 months, but it should really be tailored to your needs, considering your concerns about income stability and your amount of expenditures, investments and debt levels.

It is also very important to be aware of where this emergency fund is being accumulated. If your emergency fund is invested, it’s best to ensure that those investments are reasonably liquid and risk-free from market downturns. 

Where and How are You Spending Your Money?

Another important factor to mitigate recessionary concerns is to pay close attention to where your money is going. Taking time to look at how you are spending your money is important but identifying areas where you may be spending too much is critical. These items tend to be in the discretionary areas (e.g. entertainment and travel). It’s generally not necessary to cease all spending in these areas but reducing or reigning in those costs can make greatly aid in building up your emergency fund or handling future shocks to your employment income. 

Planning Is the Key

At the end of the day, it’s important to remember that a recession is not the end of the world, but rather, a natural part of the financial cycle. Yes, it can create financial stress, but there are things that can be done to survive it by planning now!