Disaster-Proof Your Finances Before It’s Too Late

According to the proverb, "Early to bed and early to rise, makes a man healthy, wealthy, and wise." Turns out that the combination is more apt than you might realize. As Motley Fool Answers podcast hosts Alison Southwick and Robert Brokamp explain in this episode, a "negative wealth shock" -- defined as the loss of 75% or more of your net worth -- is likely to have a significant impact on your health, and can markedly reduce your lifespan.

You read that right: Getting poor can kill you.

Since our goal at The Fool is to "make the world smarter, happier, and richer" (why, yes, we did just change our motto!), helping you avoid such unpleasant outcomes is a natural fit for our agenda. So in this segment, Southwick and Brokamp discuss the most common causes of financial disasters, and lay out some moves you can make pre-emptively to keep them from striking you -- or mitigate the effects if they do.

A full transcript follows the video.

This video was recorded on Oct. 2, 2018.

Robert Brokamp: Alison, a few episodes back we discussed this study which found that from 2013 to 2016 there was a twofold increase in the rate at which older Americans [age 65 and older] filed for bankruptcy.

Well, thanks to an article sent to me by my favorite podcast co-host...

Alison Southwick: That was me, and I sent it over Slack.

Brokamp: Yes, you did. That is true. I learned about another study that investigated the fallout from financial calamities. It was discussed in a really good article on Quartz by Corinne Purtill and the study is entitled [ready for this?], Association of a Negative Wealth Shock With All-cause Mortality in Middle-aged and Older Adults in the United States . That's pretty long. It was written by several authors, but the lead author was Dr. Lindsay Pool, an assistant professor of preventive medicine at Northwestern. This is what they did.

The study looked at almost 9,000 middle-aged Americans. They really looked at two things; No. 1, whether they experienced a negative wealth shock of 75% or more over any two-year period from 1994 to 2014. In other words, did their net worth drop 75% or more? And two, their mortality over this period. In other words, were they still alive?

And here are the findings. Of these 9,000 people, 9% had a negative net worth. They just didn't have any money or they were so in debt they had a negative net worth. 28% experienced a negative wealth shock.

Southwick: Of losing 75% of their wealth?

Brokamp: Over any two-year period. 28%. But then -- and here was the real shocker -- those who experienced a negative wealth shock were 50% or more likely to die in the following 20 years. In other words, they didn't just lose their wealth. They lost their health. The stress [part of the reason] that comes from experiencing such a financially traumatic event increased the chances that they would die.

Southwick: Or did they lose 75% of their wealth because they were unhealthy to begin with?

Brokamp: So they controlled for all kinds of factors, like preexisting health conditions, divorce [at least being divorced beforehand], and all kinds of things so that most of it was just what the effects were of the drop in their net worth.

Southwick: Was there a common thread to why people lost 75% of their wealth?

Brokamp: They didn't look at that. They just measured how much they had in things, like whether they lost a business, or whether they had a drop in home equity, or whether they had a drop in investments. And definitely one of the events that was most correlated with dying sooner was a foreclosure on your house. And this period, 1994 to 2014, includes the Great Recession, so a lot of people did have that experience in that period. It didn't get into the causes, though, of exactly why their wealth dropped.

The bottom line is, dear listeners, that we would like you to avoid a negative wealth shock and we definitely want you to live a long and happy life. So today what we're going to talk about is how to disaster-proof your finances.

When you look at what causes a financial disaster, it basically comes down to three categories. No. 1 is a loss of income. It could be a job loss. Layoffs in your industry. I remember back in the day when there were video stores. We would go to a local video store and there was this one woman who worked there. That video store went out of business. We all went to a different video store and she ended up getting a job there. That went out of business. Then she went to work at the local Radio Shack. Radio Shack went out of business. So I think of her a lot when somebody is trying to work hard but just had a series of bad luck.

The other reason you'd have a loss of income is disability. Something happens to you medically which means you can't do your job and, of course, for a household in general it could be death. One of the breadwinners in the household passes away. So No. 1 is a loss of income.

No. 2 could be an unexpected and unmanageable expense. In most situations that is medical. Some sort of thing that happens that costs you thousands and thousands of dollars. I just had knee surgery and the total cost [not to me, thank goodness, because we have good insurance] was $5,000. And I look at that and I'm like, "What would I have done if I didn't have insurance, or if I didn't have particularly good insurance?" So thank you Motley Fool, by the way, for taking care of my knee. It might not be medical. It could also be car repairs. Home repairs. Having to bail out other relatives. There are lots of reasons why you could have a big-ticket, unexpected expense.

And then No. 3 is a significant loss of assets in property. It could be your portfolio takes a significant dive. Now if it's a well-diversified portfolio over this time period, it has recovered, but that is not the case for everyone. They might have had too much of their money in company stock. They might have had a business that went under. It could be, like we mentioned, the home foreclosure.

Or for some people it's actually as simple as a loss of transportation. For probably the average people listening to this podcast, if something happened to your car you probably have insurance, or you'd be able to pay. But a lot of people, especially if you're working an hourly job, if you lose your transportation, you've lost a lot of your income, especially if you then have to rely on something like Uber until you can save enough to get another car.

Those are the three main reasons why someone had some sort of financial calamity. What can you do about that to either prevent it from happening or when it does happen, mitigate the fallout from it? Here we go.

No. 1 is to share the risk with someone else, and by that what I mean is insurance. Health insurance is crucial. Absolutely crucial. When you look at bankruptcies, the No. 1 reason people go bankrupt is because of healthcare expenses. So having good health insurance.

Southwick: Easier said than done.

Brokamp: Easier said than done.

Southwick: In many cases.

Brokamp: Yes. Life insurance is the other one. As far as I'm concerned, if someone in your family is relying on your income, you need life insurance. There's really no question about it. If no one relies on your income, you probably don't need it. But if you're a parent, or you're taking care of relatives, or you're a married couple and only one person is earning money, that person needs life insurance, and the person who's not earning money [if you're a stay-at-home parent], that person might need life insurance, too, so that there's enough money to replace and pay for the services that they're providing.

Of course, property insurance. If anything happens to your house or your car. I'm a big fan of high-deductible insurance, because it will save you a lot of money. That does mean you have to have some cash on the side, but that's what's that made for, is to take care of these big-ticket expenses that you didn't expect, but to make sure that you're adequately insured for those types of things. I'm sure maybe people right now in the Carolinas are going through this situation with all the flooding hoping that they have enough insurance to cover all that.

And the final one is disability, and I said this is the one that's always been more challenging for me. Statistically what many financial planners will point out is that you are more likely to become disabled than to die. You're more likely to become disabled before your normal retirement age than to die before your normal retirement age, and a lot of these stats come from the Social Security Administration. Basically you're three to four times more likely to become disabled before age 65 than to die. Those are the stats.

My anecdotal experience is it doesn't happen that often. I even checked this with our head of HR here at The Motley Fool, because we do provide disability insurance as a benefit. How many Fools have ever become disabled? It is pretty rare. This is one of those types of insurance where I don't say you definitely need it.

It partially depends on your job. If you're like me, as a writer, I could be pretty physically disabled and still do my job. If you are a surgeon, or if you have a job that requires a lot of physical effort, that to me argues more for disability insurance. I don't have a definite opinion about it. It's definitely something to consider.

No. 2 in how to disaster-proof your finances [it's the most boring advice in the world] is have adequate resources to replace your income or to pay for any expense. What that means, of course, is...

Southwick: Emergency funds.

Brokamp: Emergency funds! Three to six months of must-pay expenses somewhere safe in cash. It's a simple warning, but it's so important.

Southwick: Well, it's not boring. You probably think it's boring because it's advice you give to everyone.

Brokamp: And everyone gives to everyone.

Southwick: But it's still good advice!

Brokamp: It's still good advice. But it's not just that. You have other resources if your emergency fund isn't enough or you don't have it. You could rely on home equity. You could rely on your retirement accounts. But before you can even rely on those, you have to build them up. A key component of disaster-proofing your financial plan is start building up assets in any way you can do it but having something you can rely on. Even some forms of life insurance, as well. The key is just to start building that up.

Southwick: Say it again. What do you need in your emergency fund?

Brokamp: I say three to six months of must-pay expenses and the more you have kids in your house, and the more if you have a mortgage and car payments, you need a bigger emergency fund. If you're single and you rent, you usually take the subway or the metro, you're probably going to be OK if something happens to your job. You have more flexibility. That's the way I think about it.

No. 3 is keep your must-pay expenses manageable. What causes a lot of people to get in trouble is they lose their job or they have this big expense and they have no room in their budget. That usually comes down to three related things: one, a big mortgage; two, a big car payment; or three, any other kind of debt. And, of course, mortgages and car loans are just another form of debt, but basically these are things you can't get out of unless you sell those assets. So the more you can keep those manageable, the more you're going to be able to handle any other unexpected event to your financial plan.

No. 4 is get your legal documents in order. Again, this is also pretty standard advice. You need the will, you need a living will, and you need to designate your Durable Power of Attorney. And when it comes to disaster-proofing your finances, that one is key and probably underappreciated. If something happens to you and you are in no position to handle your financial affairs, someone has to be able to do that. To pay your bills. File your taxes. Make medical decisions and financial decisions for you.

That's pretty important to have in place. You don't want to have a situation where, let's say, someone's in a car accident. They're in a coma and then nobody knows anything about their finances. Nobody is legally able to make any decisions about their finances or their healthcare. You want that in place beforehand.

Southwick: If you don't have a Durable Power of Attorney, is there a hierarchy? Like your spouse automatically has [power of attorney], and if you're not married, then your mom? I don't know.

Brokamp: It depends on the state. The medical stuff -- doctors will make decisions if it's medically necessary and if your life depends on it. Finances are different. If no one can access your bank account and your mortgage has to get paid, it has to get paid somehow, and you have to go through legal rigmarole to be able to access someone else's checking account and to take over their bills.

Southwick: But that's not just Durable Power of Attorney. That's also making sure people have a password to your accounts.

Brokamp: And that's the final point. Thank you for leading into that. Basically tell people where to find it all and how to access it all. You make that document. You share it with people who are going to take over if necessary and they know where to find all of this stuff. They don't have to go routing through your files. In fact, that's difficult, because they can't even get into your house legally. It should really all be set up beforehand.

Southwick: It's so funny how it starts getting into the nitty-gritty where it's like, "Yeah, make sure they have the Durable Power of Attorney and also a key to your house." I didn't even think about that.

Brokamp: And even if it's your brother, you're not allowed to break a window to break into their house to get their legal documents. So yes, you have to take care of all of that ahead of time.

Southwick: It's almost like you need to do a fire drill where it's like, "OK, I'm dead. Go!" And then see where the process falls down. "Well, I literally couldn't get into your house to log on to your computer to pay your power bill."

Brokamp: Right. Exactly. And then of course, it's not just you, but if something happens to one of your relatives, you're going to have to be the person who's picking up the pieces so you've got to encourage them to do as well. Your siblings. Your parents. Anyone else for whom you might have to step in and take care of something for them.

The last two things. One is just work on your relationships and take corrective action if you sense any disaster ahead. We've already talked about divorce. Divorce is financially devastating. That doesn't mean you should stay married to the person, but you definitely want to try to work on that. And if you sense that is happening -- that there's a divorce on the horizon -- you have to take corrective action for yourself. You have to build up your own credit score. You have to build up your own retirement savings. You have to start thinking about your career on your own, and things like that.

But also, in any situation where someone needs help, who steps in? It's either friends or family. So to the extent that you can build a good network to be there for other people and for the people to be there for you, that will help you.

Southwick: Bro's advice. Just go make more friends!

Brokamp: Exactly.

Southwick: You need more friends!

Brokamp: Yes. And then I've got a bonus one. One more is to factor in employee benefits when choosing an employer or just knowing what's offered. A lot of the stuff we have talked about here, already, is offered by many employers. Health insurance. Life insurance. Disability insurance. Accidental death and dismemberment insurance. Here at The Motley Fool if you lose an arm, you get paid a certain amount of money. If you lose two arms, you get a different amount of money. We have that policy here.

Is there a family leave policy where you are if you have to go and take care of somebody? The ability to build and access retirement funds. Not only do I have a good match that I can retire when I want, but the more and faster you can build up your 401(k), the more you can access it in an emergency if your employer allows it. Of course, we don't recommend that, but it's good to have there if you absolutely need it.

More and more employers now have what's called an employee assistance program [EAP].

Southwick: We have that, too.

Brokamp: Yes. It's basically an outside company and they offer all kinds of services from counseling to stress leave. Some do financial planning. Some do help with debt consolidation and things like that.

Southwick: They helped us to find Hanna's day care. Which is a very competitive thing in Northern Virginia.

Brokamp: Yes, so definitely be aware of that. Some employers offer Prepaid Legal. There are all kinds of ways. Travel assistance. I just recently went through all the stuff The Fool offers, and they offer travel assistance. If you're traveling and something happens to you, we have travel assistance that can help you take care of it. Many of the problems that happen while you're away.

So No. 1, if you're out looking for a new job, factor that in. And, as we mentioned earlier, the health insurance is probably key among all of those in where you decide to work. Don't just base it on the salary. But also review the stuff that is offered by your [current] employer, because you might be offered something, already, that you just had forgotten about.

And then finally, getting back, again, to the whole mortality thing. There's just no question that there's a connection between health and wealth. The better in shape you are, the less likely you are to need any healthcare. The quicker you'll be able to rebound from any sort of health issues that you have.

There have been surveys of people in retirement and they ask them what the No. 1 determinant of their happiness is, and by far it is health, not wealth; so make sure you take care of your health, because that will have a big impact on whether you'll be in any sort of disaster, but also your ability to cope with any disaster.

The bottom line is you can't prevent the unexpected. Just by definition it's going to happen. But you can mitigate the fallout by taking steps, now, to reduce the chances that a surprise doesn't turn into a disaster and increase the chances that you'll live a long, healthy, and happy life.

Southwick: Which is what we want for all of our listeners.

Brokamp: Which is what we want for all of you.