A series of stress tests can help you sleep at night worry free A stress test is designed to determine if you have the ability to deal with a financial crisis if things go pear-shaped. It makes the impact of unlikely, but plausible events measurable and transparent, so you can see exactly if you should be worried or not about your financial situation.
A stress test is like an alternative solution to an emergency fund, but there are some differences.
Emergency funds are great, but they lack tangibility. The popular rule of thumb is for people to have enough cash in their emergency funds to “cover six months’ worth of essential expenses,” writes personal finance guru Gail Vaz-Oxlade on her blog. I’ve heard other professionals say this as well. It’s good advice, and these knowledgeable gurus are not wrong. But six months is quite an arbitrary time period Why not four months or nine months? An emergency fund is a good start to financial security, but perhaps it’s not quite enough to give you the complete peace of mind that you deserve. This is where stress testing your finances can come in handy.
A stress test will categorize all your risks, quantify them, and tell you exactly how much money you should keep on hand, and more importantly, why. It removes all traces of uncertainty and doubt from an objective point of view and offers you a strong sense of financial stability It’s also flexible and is accommodating based on your changing financial needs. For example if you renovate your kitchen a stress test can help you determine a budget and solutions in case of complications or unexpected overhead costs. A stress test will also show you warnings in the changing economy, like potentially rising mortgage rates, so you can prepare for it.
Having $15,000 or 6 months worth of expenses in an emergency fund doesn’t tell you why that amount is important, or exactly how that money would be used in a real life situation. You can’t do anything with an emergency fund except wait for an emergency to happen. But a stress test allows you to be proactive instead of reactive. If you have proper auto insurance and know that the most expensive out of pocket cost is $2,000 to fix your car in the unfortunate event that it gets damaged, then a stress test will help you maintain at least $2,000 of cash or available credit at all times, so you don’t have to constantly worry about it
But it’s not about one or the other. A stress test can be used as an emergency fund, or you can incorporate an emergency fund inside a stress test
Below are six stress tests that I have made for myself. You can use them as reference/template to create your own. Because stress tests are so granular and custom in nature, everyone’s will be different.