Is Your Financial Safety Net Big Enough?

When people learn I'm a financial advisor I get a three different reactions:

1. "Ew, get away, I don't need to be sold anything... I get free advice from my family"
2. "what are the hot stocks that I should buy to get rich quick?"
3. "I'm in trouble with debt and taxes, can you help me?"

My response to the first reaction is simple.

I'm a fee-only fiduciary. The only thing that I sell is professional advice and service, never financial products that you don't need.

The second and third are directly addressed by this article's topic, building a safety net.

Before investing in the stock market, it's important to build a cash reserve to protect you from life's shocks.

By the same token, unexpected expenses are often what lead to debt and tax problems.

So how is a safety net built? How do you know when you're safe from life's unexpected costs?

There are two measurements I look at to know if a safety net is complete.

The first measurement is the Emergency Fund. It's the number of months you could cover expenses from savings if income stopped.

A complete emergency fund for someone in their 20's is 3 months of expenses. As we get older, and surprise bills grow and multiply, a 6 month, then 12 month emergency fund becomes the target.

Pro Tip: most people think "if my income stops, I'll cut my spending way back". In reality, this is almost never true and I promise you're not the exception. Financial prudence asks us to overestimate spending, not underestimate based on planned lifestyle shifts.

Running a business? Your business needs its own emergency fund. Without emergency funds for both your household and business, financial disruptions on one side can bleed into the other. Don't let your business sink your household or vice versa.

The next metric that I check is the Current Ratio. This ratio is your cash (and cash-like assets) vs. debts due in the next 12 months.

The goal is to have a ratio of 1, meaning that your cash-on-hand can cover your debt payments due in the next 12 months.

"Current" refers to the current assets and current liabilities on the balance sheet. The "current" operating cycle is often one year, meaning these assets are available within one year and the debt is due within one year.

A current ratio below 1 means you will have to rely on future income, asset sales, or borrowing to meet obligations. In other words, you're accepting the risk that you won't be able to meet your obligations.

No Debt? Great, that makes the ratio very easy, and will make your safety net easier too. On the flip side, debt is a tool, learning to use debt wisely will allow you to maximize your financial outcomes.

Pro Tip: Emergency fund and current ratio both look to the same pile of cash to know if each is on track. No need to double up to meet both of these metrics.

If you want to know if your safety net is on track, along with 5 other important metrics, fill out this form for a free report: Free Financial Health Check

Your emergency fund and current ratio results inform when your safety net is on track, protecting you from shocks and allowing you to begin to build real wealth.

P.S. To level up your money and relationships, check out my newsletter Love & Wealth