Are you a financially resilient investor? Financial resilience is the ability to withstand life events that impact one’s income and/or assets. Some financially stressful events, such as unemployment, divorce, disability, and health problems affect people individually. Others, such as recessions, stock market downturns, and acts of terrorism, affect society as a whole.
If ever there was a year for people to be financially resilient, 2008 is it. Between the high number of home foreclosures, rising unemployment figures, declining stock market prices and home values, bank and investment firm failures, and rising costs of necessities such as food and gasoline, some would argue that consumers haven’t just been experiencing just a “perfect storm,” but, rather, a “perfect tornado.”
Research by Dr. Sharon Danes, a professor at the University of Minnesota, found that there are five characteristics that enhance people’s resilience in the face of life’s changes and challenges. These five characteristics are being positive, focused, flexible, organized, and proactive, as described below:
• Positive people view challenges as opportunities and consistently “use lemons to make lemonade.” They reframe situations positively and often use the expression “it could have been a lot worse” when comparing their misfortune to others.
• Focused people determine where they are headed in the future and stick to their goals so that life events and other barriers do not deter them.
• Flexible people are open to new and different options when faced with uncertainty.
• Organized people set priorities and develop structured approaches to manage change.
• Proactive people work with change rather than defend against it.
Financial resiliency is enhanced with financial resources, such as savings, health insurance, and a good-paying job. Another resource for financial resiliency is one’s human capital. Economists define human capital as all of the knowledge, skills, experiences, and other personal qualities that people have to “sell” to potential employers. Social capital also increases financial resiliency. This includes a support system of family, friends, co-workers, neighbors, and others that can provide financial assistance, not to mention emotional support, during hard times.
Commonly recommended financial practices can increase financial resiliency. Below are four examples:
• Maintain a low debt-to-income ratio. Monthly consumer debt payments should be 15% or less of monthly take-home pay. Ratios of 20% or above are dangerous. Example: $275 of debt payments divided by $2,500 of net pay equals a consumer debt-to-income ratio of 11% (275 divided by 2,500).
• Maintain an emergency fund of at least three month’s expenses. Keep this money liquid in cash equivalents such as a credit union, money market mutual fund, or short-term CD.
• Never consider your education or job training finished. Continue to develop new marketable skills to increase human capital and remain employable in today’s competitive labor market.
• Purchase adequate life insurance to protect dependents against the loss of a breadwinner’s income and disability insurance to provide continued income following an accident or illness.
Finally, increase your knowledge of financial topics so that you make smart financial decisions. To learn more about basic investment principles and characteristics of specific securities, visit Units 2, 4, 5, and 6 of the Investing For Your Future home study course.