|
 
Oct 2005
Index of all
past
Affiliate Corner columns
Financial firewalls can help you weather financial emergencies
By Wade Phelps,
Phelps Financial
One of the greatest problems overlooked in a family’s financial plan is the ability to be prepared for a financial emergency. According to industry research, a family experiences a financial emergency every 2.4 years. A financial emergency is defined as a loss of income for two weeks or a single expense greater than two weeks of income.
In today’s world, many use credit in order to fund these difficult times. Because of credit, many people are lax on making adjustments in their lives to be able to handle a financial emergency. The damage grows to a more desperate situation than necessary.
Create financial firewalls
One way to be prepared for an emergency is to create “financial firewalls.” In the business world, large companies set up a series of firewalls in order to protect vital information. The more firewalls that a company has, the more protected the business is. Firewalls can protect families facing a financial setback.
A family’s first financial firewall should be half of a month of their normal monthly expense placed in a separate savings account. This account should be exempt from normal banking activity with no ATM card. Studies have shown that using this technique resolves approximately 92 percent of financial emergencies.
The second financial firewall should be two and a half months of a family’s monthly expenses placed in a conservative interest bearing account. This account should keep with or outpace inflation. A savings account does not accomplish this, and the little interest accumulated is taxed. A conservative interest bearing account will probably take up to one week to withdraw from, but the savings account should take care of any emergencies until then.
The last financial firewall should consist of funds placed in places that grow tax free or tax deferred. Not all accounts with this feature require investors to wait until retirement to use without a penalty. Some accounts allow “borrowing.” Since current law prohibits taxation on borrowed funds, this way is sometimes a better option than to close an account and face possible penalty or taxes. Some “borrowed” money can be deferred from repayment or possibly never have to be repaid. Do not put all of these financial firewall funds in one account. Diversification decreases the risk of loss.
Setting up these “financial firewalls” is not the only answer to financial security. It does, however, give you the freedom to build your financial future on a more consistent basis.
|
