How to prepare for another financial crisis

On September 15, 2008, Lehman Bros. – then the nation’s fourth largest investment bank – filed for bankruptcy. It wasn’t the lone trigger of our greatest financial collapse since The Great Depression, but it did represent just how broken certain elements of the financial system had become and how dire the situation was destined to become before it got better.

Five years later, although the effects of that fallout can still be felt, the situation has improved. Unemployment is at 7.3 percent, down from a high of 10.0 percent in late 2009, but not yet back to the less than 6.0 percent we experienced prior to the crisis. The average credit card debt of American households stands at $15,185 – down from a peak of $19,000 in January of 2009. Things are better, but will they stay that way?

New agencies like the Consumer Financial Protection Bureau (CFPB) were created to provide oversight and prevent similar economic implosions from happening again, but many economists and lawmakers have expressed concern that we haven’t done enough to protect ourselves from repeating the mistakes that led to the collapse of 2008. In fact, many of the dangerous investments and risky practices that led to that downturn are still being employed today – with increasing frequency.

There isn’t much you can do personally to dissuade major investment firms from making risky decisions, but there’s a lot you can do to protect yourself in the case of another large scale economic downturn. Don’t let an improving economy be your excuse for not being prepared. In fact, times of relative prosperity are the absolute best times to prepare for a possible financial crisis.

Save, save, save

A down economy usually means layoffs, so creating a suitable safety net should be your first priority, no matter what industry you work in. Generally, it’s recommended that you maintain an emergency savings account large enough to cover your living expenses for 3 to 6 months. Those funds should be extremely low risk and easy to access.

That’s for normal emergencies. It’s difficult to predict the ultimate impact of any large scale financial crisis, so the more you can save the better. Aim to put at least 6 months worth of living expenses into an easily accessible savings vehicle, and make sure you understand how to access any longer-term savings investments and what the penalties would be for doing so.

The trouble with hitting a financial emergency without an adequate savings shelter is that the damage inflicted during this period will continue to follow you for years afterward. When you don’t have enough accessible cash to survive an emergency you start defaulting on obligations, which means ruined credit and the possible loss of assets – including your home. If you can ride out a downturn and come out the other side with your home and credit still secure you’ll be in a much better position to rebuild.

Minimize your risk

High risk usually equals high reward, and when you’re trying to grow your money, it’s reasonable to want to make investments that pay big dividends. The trick is simply to not get greedy.

Or, more precisely, make sure that you’ve covered your minimums before you start trying to make the maximum. Make sure you’ve got a suitable, stable emergency savings fund first.

And when investing, work with an expert to create a diverse mix of dependable and high yield. You don’t necessarily have to be afraid of taking risks, but put yourself in a position where you’ll be okay if those high risk investments go bust.

Stay flexible

If you’re faced with an economic crisis, it usually means that your income has either diminished greatly or disappeared completely. Your expenses, however, are not similarly affected.

That means that you’ll need to reconfigure your budget quickly to remove any expenses above the barest essentials. That can be difficult when you’re tied up in a large number of contracts and long-term agreements.

As part of your preparation for a potential financial crisis, consider all of your monthly expenses. Which ones are non-essential? Which could possibly be reduced? You don’t have to get rid of any of these expenses now, but you should understand what’s required to cancel them in an emergency.

You should also consider your financial flexibility before signing up for new services or renewing existing ones. You can often get better rates by locking yourself into long-term contracts. But how difficult is it to then cancel that contract in the face of an unexpected financial emergency? A month-to-month agreement might not carry the same savings, but it may be a better option in an uncertain economy.

Ensure your income

No job is truly guaranteed. In a major economic downturn job security goes down in practically every industry. Rather than worrying about things you can’t control, it’s important to take proactive steps to ensure your ability to earn money.

• Make an effort to become indispensable at your current job, so that if layoffs do occur you won’t be affected.
• Network with colleagues within your industry. If you are laid off, having advocates in other companies greatly increases your chances of landing a new job quickly.
• Diversify your skills and experience. Your current industry might be too deeply impacted by the downturn to offer much hope for a new job, so seek out cross-training and additional education whenever possible, and then be willing to move laterally into a different job capacity.
• Be willing to go backwards before you can go forwards. If you’ve put time and effort in to growing your career, it may be very difficult to accept starting over in a new position (especially with a pay cut and a loss of benefits). But that might be the decision you’re forced to make. Consider the pros and cons of waiting it out versus starting over elsewhere. Discuss your options with your family. It won’t be an easy choice, but the more prepared you are, the easier it will be to make.

You'll never be perfectly prepared for every possible financial emergency, but the more you do now, the better off you'll be if and when another economic crisis hits.