What is Financial Emergency? Meaning, Types & How to Prepare

What is Financial Emergency?

You can go about your daily routine doing everything right, but sometimes, something or the other chucks a spanner in the works. It’s almost inevitable really because such is the way of life. It’s unpredictable, and often it throws unexpected challenges our way. There’s no way to plan around and avoid them because of their unexpected nature, but one can prepare to smoothly get through them. There’s a good chance these unfortunate events bring with them some financial emergencies.

A financial emergency is a situation where unforeseen expenses arise, which threaten to disrupt our financial stability, like a big medical bill or loss of employment. These situations can make you feel helpless and that you got the short end of the stick, and it’s fair to feel that way. But in these situations, what matters are our actions, and having a solid plan for financial planning can make a significant difference.

Let’s take a look at the various ways financial emergencies can strike, how you can tell they’re coming, what to do and what not to do while facing these challenges, so you handle such situations successfully.

Types of Financial Emergency

There are various ways in which you can encounter a financial emergency. Some of them are:

1. Medical Emergencies

Medical emergencies are some of the most common kinds of financial emergencies. An unexpected hospital bill like surgery not only hurts your physical health but has the potential to make a real dent in your savings, especially in a country like ours where the healthcare costs are rising and most people are without health insurance. This can be made worse if the person who needs medical attention happens to be the family’s main breadwinner. 

2. A Job Loss 

The mental impact of losing a job can be draining on its own, but coupled with the financial uncertainties it brings, losing employment can be devastating. Losing your main income can make it hard for you to manage your living expenses, like affording mortgage or rent, paying bills, groceries, and other essential expenses. It can derail you from your investment strategy and force you to redeem prematurely, and it can lead to accumulating debt. This again is made worse by the rise of the cost of living in our country, not having an emergency fund, and if the main earner of the family is the one to lose their job.

3. Disasters

Natural disasters such as earthquakes and floods, and other disasters such as a fire or a building collapse can have a major impact on one’s finances. They can lead to physical injury, leave one’s home and car in need of extensive repairs, and wreak havoc on savings. Not all insurance in the market covers the damage to property during disasters so check twice before you decide on which insurance to get and review the insurance you have ongoing.

4. Family Emergencies

The sudden demise of a family member can not only destroy you emotionally but also financially. Of course, no one wants to think of such scenarios, but in case something unfortunate happens to the main earner of the family it can leave the rest of the family financially devastated. This is why it’s important to have life insurance in place. You do not want your family to suffer and get thrown into the cycle of debt.

Also Read: How You Can Secure Your Family

Recognizing the Signs of a Financial Emergency

Of course, if you’re prepared for something, you’re better equipped to deal with it, but when you don’t know what you’re preparing for, as in the case of unexpected events, it becomes important to be able to recognise the signs that something is wrong or imminent. Often these signs are right in front of our eyes if we pay attention. Successfully recognising these signs and taking action to mitigate damage is the difference between recovering with ease or getting stuck in a long and hard battle. 

Let’s take at some warning signs of financial emergencies:

• Struggling to pay bills – If you’re having trouble with the essential expenses in your budget, you have to look at making some cuts from the non-essential expenses.
• Consistently overspending – It’s easier now more than ever to overspend with all the ads and the convenience of online shopping. These small and needless expenses add up in the long run.
• Expenses higher than income – If you live beyond your means, it can have serious consequences later, like accumulating debt.
• Trouble paying off debt – If you already have a debt and it’s not going down even after making some payments, something is wrong with your repayment strategy. Reassess it and prioritise paying off higher-interest debt first so you can save in the long run. 
• Being irresponsible with your credit card – If you’re constantly using your credit card while making the least amount of payment on them, you’re heading for trouble. Not only are you accumulating debt but also hiring your credit history. 
• Insufficient emergency savings – If you do not have an emergency fund, you are more likely to be hit hard when unexpected expenses arise, while people who do have an emergency fund can get through and recover with relative ease. 

Keeping a close eye on such warning signs can help you take quick action to minimise the damage of an impending financial emergency.

How to Prepare for a Financial Emergency?

Now that you know the indicators of financial trouble the next thing to do is to prepare yourself before trouble shows up so you can deal with it. Here’s how:

1. Build an Emergency Fund

One of the most important, if not the most important weapon in your arsenal against financial emergencies is an emergency fund. The way it works is straightforward – You open a new account, different from your regular savings, and make consistent contributions till the fund reaches a certain amount. This amount differs from person to person, but the general rule of thumb is to have at least three to six months’ worth of living expenses. Just knowing that you have a contingency in case of emergencies can ease your mind.

2. Have Good Insurance Coverage

The next thing you need to do is make sure you have adequate insurance coverage. This includes health, life, vehicle, and home insurance. While your emergency fund is your safety net, insurance is your shield that will protect you and your family from the financial impact of unforeseen circumstances.  

3. Diversify Your Investments

During global or national financial emergencies, such as the global financial crisis of 2008, or the COVID pandemic, the market conditions become unpredictable. Different sectors are differently impacted, with some sectors facing massive downturns. If you put all your eggs in one basket things can get hairy. Another thing you can do to prepare is diversify your portfolio with different kinds of assets to reduce the risk of losing money.  

4. Explore Other Sources of Income

A financial emergency such as a job loss can be crippling, especially for those who live paycheck to paycheck. It’s always a good idea to have other sources of income, through part-time jobs or freelance, or have passive income streams through dividends or rental income. 

5. Create a Budget

Track all your expenses and income to get a clear understanding of where you currently stand financially and define your goals. Based on these, create a budget by dividing your expenses into essential, non-essential, and savings categories. The non-essential expenses are where you can make cutbacks to pay off debt, save more, or get more funds for investing. Now comes the hard part of sticking to your budget. If you have too many constraints, it’s going to be hard to stay motivated so make sure your budget is realistic and goals achievable. Creating a budget ensures that you are better prepared to handle unforeseen financial challenges. Stay disciplined and trust the process. 

Also Read: Understanding Budgeting in Financial Management

6. Improve your Credit Score

Your credit reflects your credit history. A good credit score enables you to get quick loans, low-interest rates, and raise your credit limit. Having the safety of a good credit score can come in handy during a financial emergency so take steps to improve your score. You should responsibly pay off all your credit on time, not have too many active loans at the same time, and have a low credit utilisation ratio to make your credit history positive. 

Common Mistakes to Avoid During Financial Emergencies

You’ve seen what to do to be prepared, but here’s what not to do during financial emergencies:

• Don’t avail unnecessary debt. During emergencies, people seek quick loans and quick loans usually come with high interest rates. It can be really easy to get trapped under the heavy burden of debt so use your good credit score to cover your expenses only where necessary.
• Don’t rely on just credit cards, however. While credit cards can be useful in emergencies, relying solely on them can lead to a cycle of debt too. Have a combination of emergency funds and credit options.
• Don’t ignore the problem. If you see a sign of a financial emergency, be quick to address it.
• Don’t hesitate to seek help from friends, family, or professional financial advisors during emergencies.

Seeking Professional Advice During Financial Emergencies

Consulting with a professional financial planner can be one of the best moves you can make during financial emergencies. He or she can help you by:

• Evaluating your financial situation objectively – You have a very subjective view of your situation. It’s normal to get stressed and not think clearly when emergencies strike and one can make hasty and uninformed decisions that have poor consequences later. A financial advisor can evaluate your losses and give solutions to mitigate and recover them.
• Providing tailored strategies to recover – Your problems and your financial situation are unique, and a financial advisor can strategize and make a recovery plan so you get back up on your feet quickly within a specific timeframe.
• Offering insights on investment adjustments – In times of emergency you might have to sell off some of your assets such as gold or land, and an investment advisor can offer insights about which assets you can liquidate. On top of that, he or she can help you by assessing your portfolio and making necessary adjustments to make back the losses.

Conclusion:

Emergencies are inevitable. What matters is how you handle them, and how you handle them depends on how prepared you were beforehand. In such situations, be quick to recognise the warning signs, and remember the above do’s and don’ts. Don’t take extra debt or be too reliant on credit cards. Don’t ignore the signs and certainly don’t be afraid to ask for help. Build a reserve of cash dedicated to emergencies, be insured, create and stick to a budget, and consult with a professional. The key is to get started as soon as you can so you can be ready for emergencies when they strike, and take them on with confidence and ease. Stay prepared!