Building financial resilience
Resilience is the ability to quickly recover from setbacks, and while setbacks can come in many forms most of them will have a financial component. So what can you do to build financial resilience?
Expect the unexpected
Rarely do we get advance warning that something bad is about to happen to us, so the time to develop your resilience strategy is now. And while we don’t know the specifics, we can anticipate events that would throw our finances into disarray. A house burning down or a car being stolen. Not being able to work due to illness or injury. The death of a breadwinner or caregiver.
With some idea of the type of threat we face we may be able to insure against some of them. If you have taken out any type of insurance policy you’ve already made a start on your resilience plan.
You can’t insure against every possibility, but you can build financial buffers. This might simply be a savings account that you earmark as your emergency fund that you contribute to each payday. If your home loan offers a redraw facility you can also create a buffer by getting ahead on your mortgage repayments.
Buffers can be particularly important for retirees drawing a pension from their super fund. Redeeming growth assets for cash in order to make pension payments during a market downturn can lead to a depletion of capital and reduction in how long the money will last. By maintaining a cash buffer of, say, two year’s worth of pension payments, redemptions of growth assets can be deferred, giving time for the market to recover.
The Internet abounds with tips on how to cut costs and save money. In difficult economic times cost cutting can help you maintain your financial buffers and important insurances.
Key to cost cutting is tracking your income and expenditure and yes, that means doing a budget. Find the right budgeting app for you and this chore could actually be fun.
Invest in quality
There are many companies out there that have long track records of consistently pumping out profits and dividends. They may not be as exciting (i.e. volatile) as the latest techno fad stocks but when markets get the jitters these blue chip companies are more likely to maintain their value than the newcomers.
This is important. The more volatile a portfolio the more likely an investor is to sell down into a declining market. This turns paper losses into real ones, depriving the investor the opportunity to ride the market back up again.
The other key tool in creating resilient portfolios is diversification. Buying a range of investments both within and across the major asset classes is a fundamental strategy for managing portfolio volatility.
With a well-diversified portfolio of quality assets there is less need to regularly buy and sell individual investments. Unnecessary trading can create ‘tax drag’ where the realisation of even a marginal capital gain triggers a capital gains tax event and consequent reduction in portfolio value.
Building financial resilience can be a complicated process requiring an understanding of a range of issues that need to be balanced against one another and prioritised. Your financial planner is ideally placed to assist you in developing your own, personalised plan for financial resilience.