Contingency Plans

by Philip Brewer on 12 February 2010 7 comments

Are you assuming that things will go along pretty much okay? Most people do, and they're usually right. Even when they're wrong, it tends to be okay, because the typical household's finances can absorb the occasional small blow. But sometimes the blows are medium-sized or large. What do you do then?

I've written before about handling the large financial blows. (In particular, I've written about losing a job and about moving your household finances to an emergency footing.) Dealing with the medium-sized blows is easier, but at least as important. After all, they're more common.

Sometimes the blow falls on the income side: Wages or salary cut, hours cut, an expected raise or bonus deferred or canceled, falling interest rates or dividends (a big deal for those living on capital). Other times on the spending side: Unexpected expenses, rising prices. So, how do you handle problems of this sort?

Well, the short answer is that you handle them in the obvious way. In the very short term you dip into your emergency fund, cut back on savings (or cut back to the minimum on repaying debt), or even borrow money. Then, in the medium term, you hustle to boost your income and take steps to cut your spending until things are back in balance (and you can replenish your emergency fund and resume normal saving or accelerated debt payments).

The longer answer, though, is that it's worth having a plan — because taking one of these medium-sized blows to your home economy can prompt you to make unwise decisions when you try to play it by ear.

We just had a good post on making an emergency plan for how to hold your emergency fund, how to access it in the case of an emergency, and what steps to take if the emergency outstrips your funds. The distinction here is that not all contingencies are emergencies. In fact, the whole point of a contingency plan is to keep contingencies from becoming emergencies. That's why it's worth going to the trouble of making a plan now, rather than waiting until it's an emergency.

Make your plan

Everybody's budget is a compromise between the cheapest way you could meet your actual needs and the most luxurious way you could satisfy your slightest whim. But there are many, many decisions embedded in that compromise. A contingency plan makes those decisions explicit, so that you know which dollars are going to the least important wants. Then you know where to cut when you get hit with falling incomes or rising costs.

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As a bonus, actually making a plan informs your long-term commitments. Imagine that before you took out a car loan or signed a lease, you rejigged your contingency plan to allow for the new fixed expense. Seeing exactly which expenses might have to be cut if your finances took a hit might make you reconsider.

Strategies for implementation

Things change, so you don't want to just blindly follow a contingency plan that you made months or years ago.

Especially in the case where rising costs for specific categories are the problem, one thing to do early is to look at cutting those very costs. If the problem is rising food prices, take a fresh look at what you're buying at the grocery store — it's rare for all prices to go up the same. If the problem is rising fuel prices, take a fresh look at thermostat settings, at combining trips, carpooling, mass transit, etc.

Of course, at some level you ought to be doing this all the time. But once you've done it once (taken a serious look at where your spending is going and compared it to where you get the most satisfaction), the payoff to doing it again is going to be smaller. But when things are changing — especially when things you buy are rising in price faster than things you don't buy — it's worth doing again.

Probably the most common element of a contingency plan is simply deferring expenses. In many cases you can (temporarily) make do with what you've got, freeing up the portion of your budget that would have handled upgrades to cover contingencies.

Thinking about these things in advance makes it a lot easier to adjust smoothly to the little financial glitches that we all face.

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Guest's picture

Always have a Contingency plan, you have to know what your plan B is. If you have a plan B ready to go, you can absorb a big hit faster. Chance favors a prepared mind! And who knows, that plan B might just become your plan A.

Philip Brewer's picture

@Richard van Seenus:

Right!  One of the big benefits of contingency planning is that just doing the thinking shines a light on your default plan.

Every time you think, "Well, if prices go up (or my hours get cut), I'll just buy less X," it's a signal that you should at least consider buying less X right now. That's not automatically the right thing to do—no doubt you really enjoy the X that you buy, or you wouldn't be buying it—but these things are all connected to one another. If you bought less X you could do something else with that money—boost your savings or buy more Y.

Making a contingency plan certainly doesn't mean you have to activate it, but it does give you a framework within which to think about what among the things you spend money on are more or less important to you.

Guest's picture
Guest

What about your last post- the one about NOT making a plan?

Philip Brewer's picture

This post and the previous one (Is Just Leaving Some Slack Better Than a Plan?) are intended as a pair.

Budgeting—especially the way most people do it, where they budget down to the penny—suffers from the flaw of being inflexible. One way to deal with that inflexibility is to just leave some slack in the budget. You can do that either casually (by simply not budgeting down to the penny) or explicitly (by including a specific amount of slack in the plan). Either way can work.

But I think, especially if you're a natural planner anyway, making a contingency plan is superior to either option. You get the advantages of planning down to the penny—no slack left sitting around waiting for you to figure out what to do with it—while also getting the flexibility that slack provides, because you've already decided which aspects of your plan only go into effect if things go well.

At least, that's what I meant to say.

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Mick

When purchasing groceries we have started looking at other cheaper brands. I've always been caught up on picking up the highest profile brand because it must be the best. Now I discover that i've been a fool to marketing and there are smaller brands that are even better at a lower price.

Philip Brewer's picture

For something that you buy over and over again (tomato paste, let's say, or breakfast cereal), it really pays to buy a small quantity of the cheapest you can find—so you can test if it's just as good as the more expensive stuff. Often it is.

Over a period of years, the cost difference can really add up. And, if your test sample doesn't provide the quality you want, you can buy the expensive stuff instead, for the few cases where it matters to you. (For example, I buy expensive toothpaste and facial tissue.)

Guest's picture
Mick

We live reasonably near 3 supermarkets. When we know the product/brand we want we have 3 different lists developing the cheapest/shop lists. I notice some lines do vary quite considerable shop to shop. It works quite well for cereals, milk, tins etc.

We were bulk buying but then realised one of the stores would have an other e.g. 3 for 2 which would have been cheaper if we had gone for that.

So now our tactic has changed slightly. For example we know that somewhere there will be a cat food offer of 2 for £5. We bulk buy this as much as possible knowing that when it runs out another store will offer the same deal.

Overall, it helps keep a close eye on pricing in our area.