10 Steps to Increasing Your Financial Resilience

Now that the global economy seems to have settled down a bit, most people are rubbing the financial slumber from their eyes and trying to figure out what happened and how to better prepare for the future.  As I’ve thought about the economy and personal finance in the past few months I’ve continually come back to the idea of becoming more financially resilient – basically, becoming better able to withstand and even thrive during future economic downturns.

It’s nearly impossible to become completely independent of the world markets, but the following are a few ways to help ensure that if things go south in a hurry (they will again, someday, sometime), you will survive and won’t be swept up in the wave of financial destruction:

1. Learn to track your spending – unless you can get a grasp on where you money is going each month, you have no basis for managing your finances.  With the availability of free online budgeting software like Mint and Wesabe, there is no excuse for not being able to track your spending.  Once you can categorize and measure the various financial transactions you make on a regular basis you can then develop a realistic spending and savings plan.

2. Be merciless with debt - during the past two years of financial wreckage, the first people to go under have often been those buried in debt.  An unexpected job loss, pay cut, or rise in interest rates can overwhelm anyone with a high debt-to-income ratio.  Whether you start with the smallest balance first, or the one with the highest interest rate, the important thing is to rid yourself of debt as quickly as possible and avoid accumulating more.

3. Cut costs/D-I-Y/Sustainability – to become better off financially there are only two options: spend less or make more money. Cutting costs is often a much easier short-term solution to increasing our wealth. Start by looking at your monthly expenses (see Step 1), identifying your biggest costs and whether or not they can be reduced. Do you have interest rates or fees that can be negotiated down? Subscriptions that you don’t really use? A simple phone call may save you hundreds, it costs nothing to ask.

Second, identify things that you could produce yourself. For example, my wife and I discovered that our monthly grocery bill was larger than we liked, but felt that much of it was due to our desire to eat healthy, fresh foods, specifically produce. Rather than cutting this out of our diet, we made the decision to plant a vegetable garden this coming spring. It won’t completely replace the grocery store, but growing our own tomatoes, lettuce, cucumbers, etc. will save us a significant amount of money over time, provide us with healthy, organic food, and insulate us from rising food prices.

4. Develop multiple streams of income – the second part of the wealth equation deals with making more money in the first place. Even if you have a full-time job, you can increase your financial resilience by developing multiple streams of income. For example, while it doesn’t earn much, blogging provides me with an additional source of income.

Focus on developing passive income, or income that comes from activities that don’t require your full-time engagement. Examples of this would be rental income, advertising revenue from websites/blogs or royalties from publishing a book or other intellectual property. Think “set it and forget it.” By increasing your streams of income you help ensure that if one stream dries up you are still able to survive.

5. Build an emergency fund – If you live paycheck to paycheck you are not alone, but you’re playing a dangerous game.  No matter how well you budget there are always going to be unforeseen costs and emergencies.  Car trouble, medical issues, last-minute travel, etc.  The way to make sure these events don’t crush you is to build an emergency fund.  Trent at the Simple Dollar explains,

“An emergency fund is cash that you’ve saved up for the sole purpose of helping you maintain your normal life through the emergencies that life hands you. “

Check out his awesome step-by-step guide to building an emergency fund here.  Various numbers on how much you should have in savings get thrown around by the experts, but 6 months of income is a good place to start.

6. Maximize contributions to Roth IRA – there is no better retirement vehicle available to young people today.  The Roth IRA allows the money in your account to grow tax-free and keeps you from having to pay taxes when you begin to withdraw payments come retirement time.

Do everything in your power to contribute the maximum ($5,000 for 2009) each year.  It may not seem like much at first, but if you start in your 20’s the magic of compounding interest can work for you and provide you with a good chunk of retirement income.

7. Diversify investments – “I believe that 98 or 99% – maybe more than 99% – of people who invest should extensively diversify and not trade. That leads them to an index fund with very low costs.” Warren Buffett.

The principle laid out by the Oracle of Omaha is sound advice for investors.  Since you don’t have enough knowledge (worry not, even the “experts” on CNBC don’t) to consistently and accurately predict which markets will provide the best returns and which will tank in years to come, invest in all of them.

How does the average 20-something do this?  By investing in low-cost index funds like the Vanguard S&P 500 Index Fund, which purchases shares of every company in the S&P 500.  By taking out the guess-work (excuse me, ehem, “technical analysis”) of fund managers the funds are able to charge the investor significantly less.  For more info check out Ramit Sethi’s in-depth post on mutual funds.

Of course, diversification extends beyond stocks.  Many have found real estate to be a profitable place to invest, as well as bonds, commodities, currencies etc.  However, for the average investor, index funds provide a great place to start.

8. Learn entrepreneurship – entrepreneur and author John Robb explains, “One of the best ways you can prepare for the future is to train yourself to become an entrepreneur — essentially a person that makes their own economic opportunities.”

Not everyone dreams of running their own business, but as more and more jobs are outsourced to countries who can do them for less money, the types of skills that may help you survive are those found in successful entrepreneurs.

Start small, test fast, fail fast and keep going.  Entrepreneurial opportunities are often much closer to home than you may think (sounds eerily like a piece of fortune cookie wisdom).

9. Nurture relationships – Very few people get through life without depending on the generosity, wisdom, or partnership of their friends and families in reaching their financial goals.  Besides the obvious benefits of having people to bail you out if you find yourself in trouble, relationships provide you with a network of people who can give you advice, mentorship and in some cases capital for a start-up or investment opportunity.

By nurturing close personal relationships you tap into a greater resource than any bank or investment firm could ever offer you – people who share in your vision and authentically want to help you succeed.  And in the end, no amount of money will fulfill if you don’t have people to share and enjoy it with.

10. Hold on loosely – Some of you might be asking, “Wait a minute Cameron, you just got done telling me how to make more money and keep it, now you’re saying to loosen my grip?”  Absolutely!  Money is a great tool, but it has an amazing ability to corrupt people who make it the chief end in itself.  When taking positive steps to better your personal finances it’s easy to become greedy as you witness just how much is possible with a few solid decisions and some daily fiscal discipline.

How do you fend off greed?  Simple, by giving money away.  Being rich isn’t about the bling, it’s about freedom.  For me this means the freedom to support my family and bless others at the same time.  Many of my friends are involved in some incredible non-profit organizations and missions – being able to support them is one of my favorite things in life.  Holding on tightly to your money may help you feel in control, but in the end it keeps you from receiving a much greater reward, the joy of helping others.

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