4 steps to achieve financial stability

What is financial stability?

If a household encounters financial pressures which mean that its access to money is sharply and unexpectedly reduced, so that it has to reduce its spending abruptly and by a large amount, then that could be described as a financial crisis, or an episode of financial instability, for that household.

W.A. Allen and G. Wood in the Journal of Financial Stability 2 (2006) 152–172

Reasons for financial instability

A common reason your access to money reduces suddenly is job loss. At macro level, nations and governments experience financial instability which trickles down to the micro-level. Companies and individuals often get affected.  The current pandemic and lockdowns have economic implications for many industries, with some more affected than others including prudently managed companies. Economic cycles are part of life. The booms, and bursts as they call them are a sure thing. The question is never how to avoid them but how best to prepare to survive periods of economic uncertainty, sudden loss of income, and increased financial pressures.

As with most people, financial pressure is something I have experienced and continue to experience so here are my top tips to achieving financial stability.

4 Steps to achieve financial stability

Set a financial goal

If you have a desire to be financially secure or independent, it will inform your behaviour and attitudes towards spending and saving. So, ask yourself “what is the financial goal”? Then write it down and break it down into short and long-term objectives e.g. To pay off my mortgage fully in 10 years.

Keep expenditure below income

Keeping your expenditure well below your income means you will have some money left to save and invest. It is also important to recognise the difference between needs versus wants, Assets and Liability, and Fixed versus Variable costs. You don’t need to wait until a time of financial crises to control expenditure. An income and expenditure budget is also essential in ensuring your financial goals are being met.

Avoid debts

I remember discussing with someone about credit cards when I first came to the UK and they referred to it as free money. This left me puzzled and I asked: “don’t you have to pay it back”? Strangely, some people have this attitude to debt. I am extremely uncomfortable with borrowing and keep within very low limits for my peace of mind.  I also find that when we experience financial pressures, it helps not to have that extra £400 monthly loan repayment, this makes the emergency fund (see below) go even farther. There are instances when debt is good e.g. for investment purpose, those instances don’t apply to personal finance especially when it is funding a lifestyle deficit or used to take on excessive risk.

Set up an emergency fund

An emergency fund has been a lifesaver when I have been in between jobs, it is crucial to have one. To determine how much to save in an emergency fund, add up all your monthly expenditure (rent/mortgage, utilities, food et.c). Then multiply total monthly expenditure by the number of months you are saving up for. For example, if your monthly expenditure is £2,500, a 6-month emergency fund will be (£2500*6) £15000. You can work on building your emergency fund gradually. Should an emergency arise, you will have this to fall back on but ensure you top up your emergency fund to the required level when your finances get better. I would recommend saving between 3-6 months of expenditure in an emergency fund. You will need to have these funds in an easily accessible bank account, preferably a separate one to your regular bank account.