NEW YORK – Could your finances survive a stress test? If you’re unsure, it might be time to play a game of Wall Street regulator at home.
The idea behind the Obama administration’s “stress tests” is to gauge whether the nation’s 19 largest banks are financially sound. Regulators are expected to put firms into three groups: those that are healthy, those that need more money and those at risk of failure.
For the purpose of your home experiment, let’s assume a scenario where you’re laid off, have a medical emergency or need major repairs on your car or home. Could you make ends meet? If so, for how long?
“The ideal situation is that you prepare when you still have time,” said Karin Maloney Stifler, a certified financial planner with True Wealth Advisors in Hudson, Ohio.
The rule of thumb is that you should maintain an emergency fund of three to six months of living expenses. But emergency funds are often an ideal rather than a reality. And with the ranks of unemployed in March being out of work for an average of 5 months, chances are you’d have to dig deeper.
To gauge your ability to pull through a financial calamity, work through the four steps below. For each, rate your strength on the topic from 1 to 5. Give yourself a 1 if that aspect of your finances couldn’t provide any help in an emergency; give yourself a 3 if you feel the area could use some work; and rate yourself a 5 if you feel entirely comfortable with that part of your financial plan.
If you score less than 3 on more than one area, it might be time to start fortifying your financial plan.
• STEP 1: CHECK THE ACCESSIBILITY OF YOUR RESERVES
In an emergency, how quickly would you be able to get to your cash? How much money do you have available, including certificates of deposit, emergency funds and retirement accounts?
Keep in mind that getting a loan will only get harder if you’re laid off. So if you currently fear losing your job, tweak your strategy accordingly. That means thinking twice before locking up money in long-term CDs or retirement funds.
“You want to focus on preserving your money rather than growing it,” Stifler said.
If your money is already locked up, factor in any penalties you’d have to pay to get it out.
With CDs that last two to 18 months, for instance, penalties of three months’ interest are common, according to Bankrate.com. So if you put $10,000 in a 1-year CD with a 2 percent rate and wanted to withdraw money after five months, you’d forfeit around $50.
For future reference, remember that one way to avoid problems with tying up your savings is to set up a “ladder” of CDs with staggered maturities.
As for counting on retirement accounts, think again. You can’t borrow from your 401(k) once you’ve been laid off. And there are only limited circumstances where you can take a hardship withdrawal. Plus, taking a distribution before you’re 59 1/2 means paying a 10 percent penalty — that’s in addition to the income taxes on the withdrawal.
Your best bet is a Roth IRA, if you have one. This lets you take out any money you contributed without penalty since it’s after-tax money. To take out any earnings before you’re 59 1/2, however, you’ll need to pay a 10 percent penalty.
• STEP 2: DETERMINE WHERE YOU CAN SLASH EXPENSES
Examine your spending and weigh every expense, no matter how trivial. This exercise will help create an emergency budget you could trigger in a dire situation.
“Think of things you don’t think are significant. An extra $10 or $20 for cable or phone service or Netflix can all add up to $100 or more a month,” said William Driscoll, a certified financial planner and president of Driscoll Financial in Plymouth, Mass.
Ask everyone in your household to bring ideas. Your spouse might agree to stop buying lunch at work. Your teenage daughter might limit her text messages each month. You might cut back on movies and books.
You’ll probably discover a slew of cuts worth making immediately. Other cuts can be saved for when the stress arises.
• STEP 3: ASSESS INCOME SOURCES
On top of spending less, you need to figure out ways to supplement your income if your finances come under pressure.
For instance, don’t expect to get by on unemployment checks alone. The figures vary depending on the state you live in, but benefits on average are 50 percent of your wages, with a cap on how much you can get. In California, for instance, the weekly cap is $450.
If you’re married, ask if your spouse could take on additional overtime. While you’re at it, be sure that you’re keeping each other posted about job security. The last thing either of you need is to be surprised.
Check in with human resources, too. You need to know what short-term and long-term disability benefits you can count on in a medical emergency. How long do benefits last and how much money can you expect?
Another source of cash might be right under your nose. Look around the house. Is there a room you could rent out? How about items you could sell? Make a list of everything you think could sell and estimate how much each item is reasonably worth.
“In an emergency situation, you have to take stock of whatever you have and use it,” Driscoll said.
• STEP 4: EVALUATE YOUR SUPPORT NETWORK
When planning for an emergency, friends and family might be your first thought. But they should be tapped as a last resort, Stifler said.
Many people are struggling right now, and it’s unfair in any scenario to expect someone else to support you.
That said, there may be very close family members you feel comfortable talking to about a loan in a true emergency. If so, be clear on how much they could afford, and under what terms.
“You have to be ready for the possibility that a family member might say no,” Stifler said.
If you’re not comfortable broaching the topic, don’t count on their help as a sure bet.