Prepare for the uncertainties of life
30 September 2019
1. The stress test – the new buzzword
Do you remember the dark days of the financial crisis in 2008? The financial markets were in turmoil and there was blood on the streets. The talking heads on Bloomberg were in despair and stock markets around the globe were abandoned as if the plague infected it. Your favorite share kept dropping like a falling knife, day after day. In the midst of all of this, a new buzzword was in the making namely “the stress test” for the big financial institutions. As per Investopedia:
- “A bank stress test is an analysis to determine whether a bank has enough capital to withstand a financial crisis, using a computer-simulated scenario.
- Bank stress tests were widely put into place after the 2007-2009 global financial crisis.
- Federal and international financial authorities required all banks of a certain size to regularly conduct stress tests and report the results thereof.
Banks who failed their stress tests had to take steps to preserve or build up their capital reserves.”
Because this links directly into your Personal Financial Plan, the “stress test” is relevant. In a nutshell:
- All of us should have an obligation not only to ourselves, but also towards our family and loved ones to conduct our own mini version of the stress test on a regular basis.
- A stress test of your financial planning is much like a health check. Like with many health conditions, you will have time to remedy a small potential problem when you identify it early on.
- How do you protect your financial plan against the uncertainties of life i.e. disability, dread disease, or even premature death? Unless you are clairvoyant and well prepared, many of these will hit your financial planning like a Mike Tyson uppercut, down for the count.
- A vital part of your personal financial plan should be that you insure yourself and your financial dependents against the risks of life. These uncertainties do not have a date or a timeline attached to it.
- By doing this, you ensure that there is enough “capital” available to withstand a financial crisis when any of the uncertainties of life strike, much like the stress test of the big financial institutions. This is the benefit of insurance.
- Financial needs and obligations differs from individual to individual. It will even fluctuate depending on the specific life stage when disaster strikes. A person who is just starting out in life normally has different needs versus someone with a family, a mortgage and children.
- You need to conduct your financial stress test on a regular basis to ensure you have an adequate funded personal financial plan.
2. What is life insurance?
Insurance means risk mitigation, nothing more nothing less. Most of us do not have the financial ability to confront life's crises head-on. For example, on death, there is always the risk that your family and loved ones will find themselves in financial difficulty. Life insurance is a way to mitigate this risk. Sufficient life cover will ensure that your executor can settle all debts, last expenses and taxes of your deceased estate. This cover may also safeguard the financial security of your dependents.
In life, you expect to earn an income, acquire assets and utilise these assets for the purpose of retirement. However, should you experience one of life’s nasty surprises; it could throw the grand financial plan in absolute turmoil.
Back to the question: What is insurance?
- For the average person on the street, it is almost impossible to be financially ready for life’s uncertainties.
- By using insurance, we can transfer the risk onto an insurance company for a fee known as a monthly insurance premium.
- These financial institutions are financially strong enough to carry the risk.
- Insurance is a means to protect you and your family financially in the event of a crisis.
Insurance vary for almost every need and risk:
- Life insurance;
- Credit life insurance;
- Disability insurance and income protection;
- Dread decease cover;
- Medical aid cover;
- Short term insurance on assets like your vehicle and your house;
- Pet cover for that week-end emergency when Bella, the cat, decides to call in sick
Not the complete list, but where there is a need to protect you against a risk, you will find cover.
3. Get life insurance – or whatever other risk you need to cover
Similar to your personal financial plan, your risk management plans are never completed. This planning process must be revised periodically because risk changes constantly.
To manage risk in your personal financial plan, use the following five steps:
- Identify the risk i.e. premature death, disability, accident and medical expenditure, to name but a few.
- Calculate the risk: what will the financial impact of the risk event be on your personal financial planning, your financial position and obligations?
- Decide how to control or mitigate the risks that you have identified.
- Implement a solution. This is where insurance products come into play. Most of the time insurance is a very cost effective way to mitigate your financial planning risks.
- Revise and revisit your personal risk management plan on a regular basis. Insurance calculators and insurance quotes can help you implement an effective plan.
As part of your risk management plan:
- Remember the basics of your personal financial plan;
- Compare the cost of risk mitigation to your other financial goals;
- Do not risk a lot for a little. The choice is either financial ruin or a monthly insurance premium.
- Do not cut corners when it comes to what insurance type you need and how much insurance you need. Benjamin Franklin once said that the bitterness of poor quality remains long after the sweetness of low price.
- Contract with a trusted financial advisor to assist you.
4. How much life insurance or other insurance do you need?
“How much” is a function of your needs and wants. For example, on death there is certain costs and possible taxes such as estate duty that your executor needs to settle. Your family may depend on you financially. Do you know how much you will need should you become disabled and are no longer able to earn an income?
With the help of insurance calculators (financial needs analysis), you can quantify these costs and needs as a lump sum insurance. The financial planning market is flooded with tools and calculators. The DIY approach may be dangerous because of all the factors and legal issues that you need to consider. You will get it wrong somewhere along the line. Use a trusted financial advisor to guide you through the pitfalls and get the full benefit of insurance.
Disclaimer: The advice contained on this blog is for general purposes only and does not take into account individual circumstances, objectives or financial needs. Accordingly, readers are advised to seek appropriate advice from licensed professionals prior to making any investment, or taking up a financial product or service.