House of cards: How one financial misfortune may trigger others

One of the first pieces of advice that financial gurus generally give is having an emergency fund equivalent to six- to nine months of expenses in cash, to use whenever an emergency strikes. I think that only having this emergency fund may not be enough, though, because it underestimates the likelihood of compound risks: the possibility that one financial disaster can cause another. Let me explain why…

A couple of years ago I was retrenched. I have always been relatively responsible with my finances, so the loss of my job was not a complete disaster for me. My thought process was: “I lost this job, I’ll just do something else. Anyway, I have nine months of expenses saved up, so I have a cushion”. My heart was also not into the job anymore, so the whole situation ended up being a bit more of a relief than a worry.

What I did not realize at the time and soon discovered was that my expenses before and after the job loss were drastically different. You see, I had negotiated not to pay any rent or celphone use during the employment period. This was my first real job so I had never realized how much a celphone package costs! I had anticipated paying some rent, but never took into account having to pay for a normal celphone package. Health Insurance was also going to be a whole lot more expensive.

This is what I mean with compound risks – one bad event causes others.

Another good example is illness.  You’re Medical Aid only covers a certain amount. If your costs are above the threshold of what the Medical Aid will pay, you will have to sell assets, or even your house to cover extra expenses. You have also now lost your income, since you cannot work. Will a 9 month Emergency Fund last this type of financial onslaught?

It depends.

These days there are many different insurance products that can provide a protection against these adverse circumstances. These include income replacement policies, disability insurance and hospital plans, for example. An “income replacement policy” provides income in the case of an adverse event, such as a job loss, for a certain time period. “Disability insurance” provides income if you are disabled and cannot work, while a “Hospital plan” provides cash for every day that you are in hospital without specifying what you should spend it on.

These could provide you with the cushion that you need if multiple events occur.

Is this risk worth the premiums to pay for these new policies? You will have to decide based on your personal risks and needs. It is worth consulting a financial planner to check on your risk profile and needs.

Having a Emergency Fund is great, but I think it is prudent to also supplement your own resources with relevant insurance products. This way, there is a good possibility that you are covered if multiple bad events occur.

Kevin Mzansi

Image by DieselDemon