The prudent see danger and take refuge, but the simple keep going and pay the penalty. Proverbs 22:3
Probably the biggest reason many people run into financial difficulty is the fact they have no plan at all, but that’s a topic for another day. For those who have formulated a financial plan in some area I think there is one very simple reason why these plans often fail.
The reason many folks’ financial plans don’t work out as they had hoped is they forget to factor in risk. We make our plans based on everything going as we expect. But how often does life work out exactly as we think it will? Life can be messy. Unexpected things happen. A friend or relative we were counting on lets us down. A doctor’s diagnosis changes our future radically. An unexpected pink slip. These things are often just a part of life.
When the unexpected happens
When we don’t take into account what might go wrong we almost guarantee our plans will fail. And yet often that’s just what happens.
- We use our credit card for our purchases because we pay it off each month and we get such great perks. But then a month comes where the water heater breaks and the alternator goes out and Jr. breaks his arm and we can’t quite make the payment. That’s ok we’ll catch up next month, but then something else happens, and so on. We look up 6 months later at a $5,000 credit card bill and wonder how we got there?
- The banker says that we should have no problem affording the mortgage payment on that new house with our combined income. Then an unexpected layoff comes, or babies come and mom wants to stay home with the kids and the income is now cut in half. Suddenly that “affordable” house payment leaves us facing possible foreclosure.
- The young student is planning to be a doctor or a lawyer and doesn’t worry about the six figure student loan debt she has because she’ll be making a great income. But then she finds it more difficult than she thought to get that great job, or when she actually starts pursuing the new career she finds she hates it but is still saddled with a mountain of debt that limits her choices. Or worse yet she fails to complete the degree and now she has the debt and no degree to get that great job.
- We drive a lot for work and the boss offers us a $600 a month car allowance so we go buy a brand new vehicle because “it isn’t costing us a thing”. Then the economy takes a turn for the worse and we get laid off. Now we have no income and a $600 car payment.
- Our best friend approaches us with a “can’t miss business opportunity” and wants us to go into partnership with him. Things are going great until he’s sued because his 16-year-old got in an accident and someone was seriously injured, or his wife files for divorce, or perhaps he decides he just doesn’t want to pursue that business anymore.
- We get a nice inheritance and could pay off the house. But our adviser tells us it would be stupid to pay off a loan that’s 3 or 4 percent when we could be making 10 to 12 percent. Then the economy hits a land mine like it did in 2008 and our investments are down the drain and we wish we had a paid for house.
These are just a few examples. Maybe your plans will go as expected, but maybe they won’t. This is really all about risk. So how do we keep risk from sinking our financial plan?
- Never make a major financial decision without considering what could possibly go wrong.
- Always have a backup plan. And it’s a good idea to have a backup plan for your backup plan. The more options you have, the better chance you have to weather life’s storms.
- Have an emergency fund. Having some margin in your life will help those bumps that are bound to come not be fatal.
- Have a budget. When you know where your money is going and you are spending it with a purpose, you are much less likely to make poor decisions.
- Understand that while many people argue the merits of “good” debt vs. “bad” debt, debt always introduces an element of risk. You may decide the benefits you receive from that debt are worth the potential risk, but do not deceive yourself into discounting the fact that there is an element of risk there.
I don’t want to sound depressing and I don’t mean to imply that every financial decision we make is bound to fail. Sometimes things do go according to plan. But often life doesn’t work out like we thought it would. Be very careful if the only way your plan will succeed is if everything goes right.