Canadians need to prepare for unexpected events and calamities, by purchasing insurance and creating a financial plan, and if possible, arranging for sources of short-term contingency funds, says Bill Bell, a financial advisor with Manulife Securities Incorporated in Aurora, Ont.
Large numbers of Canadians are unprepared for the unexpected. More than 40 per cent are unprepared to handle their financial obligations in case of an emergency, surveys have found.
Expect the unexpected, Mr. Bell says. A former high school math teacher, he went into the insurance business in 1984, became a financial planner in 1996, and is the author of two books on finance – Simple Money (2007) and One Step to Wealth (2000).
Q: What are the foundations of a sound financial contingency plan?
Bell: You need to insure against the catastrophic – a permanent disability that stops your ability to earn income, a fire that burns your house to the ground, the death of a breadwinner. Ask yourself: What are the unexpected things that will stop me in my tracks?
Q: What are some strategies of where to keep or access emergency cash?
Bell: Increasingly, we're getting away from telling people they should have six months of salary in the bank, and instead we're saying, have a line of credit that can handle that for you. But you need to be able to repay that line of credit, in a reasonable amount of time – in my mind a year or less. That depends on the situation. A Tax Free Savings Account is a perfect vehicle for a contingency fund, because you can take money out, not pay any taxes, and put it back in later.
Q: In life, things never go exactly as planned. How worried should people be about coming up short financially when unforeseen needs arise?
Bell: The first thing I say when I deliver a plan to a client is here's a pretty picture, but this isn't how it will turn out. There are so many assumptions – inflation, returns, income – and we're trying to be conservative across the board. But looking back at plans, one thing that has consistently been wrong is that people made more money than they had projected. So that helps to offset some of the negative things that will also happen.
Q: That won't be true for everyone. If people are thrown off course financially because of something unforeseen, what do you advise?
Bell: I use the analogy of a flight. You can have a massive headwind or a bad storm and the plane has to go around it. You may even have to land unexpectedly. So what happens? The captain re-jigs the flight plan and gets you there.
Q: And when we have the financial equivalent of a rough flight?
Bell: You revise your financial plan – increase your savings, push out your retirement, reduce your expenses, maybe move to a house that's less expensive. What does the plan look like if you work an extra year? Often, that solves all the problems. There are all sorts of things you can do if something has happened to prevent you from getting where you want to be, when you want to. There are all sorts of moving parts in your plan that allow you to make adjustments.
Q: What about the more common situations, like when you need a new roof or you're out of work temporarily?
Bell: An important part of planning is looking at your cash flow and whether you can change your spending habits. Just realize where you're spending. Look at your expenses, go back a few years, and you'll see a steady flow of things you didn't expect to spend money on. You didn't set aside money specifically for a furnace repair. But things will go wrong and you'll have to come up with money to pay for it.
Q: You talk about cash flow. So beyond having any financial reserves, you're also saying that you need to understand what flexibility you have in your budget.
Bell: A lot of people are spending 100 per cent of what they're making. That's a problem right away, because you have no room for any contingencies.
Q: When people think of planning, they tend to focus on their dream future. Why do we overlook planning for the unfortunate?
Bell: We're usually planning for our retirement, or to send our kids to school. It's not only human nature but it's healthy to think of a future that's positive. All financial advisors encourage you to pursue goals that are optimistic. What kind of life would it be if we just worried about whether a car might hit us?