Pessimistic Personal Finance: The Three Fuses

One of the nice things about blogging is that you get feedback.  You take an idea and you throw it out there.  If there’s a better way of seeing things, someone is bound to tell you.

With that introduction, I turn to the topic of the day: pessimistic personal finance.  These are scary times.  We’ve all seen the stock market plunge, but really the stock market is the least of our worries.  Unless credit frees up, we’re going to see economic disaster over the course of the next year.  We already know it’s going to be bad, but no one knows how bad.

I live by the motto that pessimists are rarely disappointed and often pleasantly surprised, so with that in mind, I looked at our family finances and calculated three metrics that I call fuses.  What is a fuse?  A fuse is a duration of time until  a bad thing.

The first fuse is what I call the normal fuse.  Assume some set of catastrophes knocks out all of your income.  How long can you and your family live on what you have now, without changing your spending at all?  You can calculate this fuse by taking your cash (pretty much anything liquid and not at the mercy of the market) and dividing it by your monthly spending.  The number you get is a duration in months.  That’s your normal fuse.

The second fuse is the ‘bunker’ fuse. Assume the same set of catastrophes and calculate your fuse, but this time divide your cash by your monthly spending in ‘hunker down’ mode.  In ‘hunker down’ mode, you’re spending only what you need to for rent/mortgage, insurance, and groceries.  You jettison all non-essential spending.  Again, don’t factor in things that can evaporate in the stock market.

The third fuse is the big one: the Armaggedon fuse.  Take the total of all of your assets, your retirement, your house, your investments, and any money on hand, and divide that by your essential monthly expenses.   Then, factor in the inflation rate, and you get your fuse. 

There you go.  Even if you aren’t a pessimist, I think these are good numbers to know.  If you know them, you can rest at night knowing exactly how you’d fare during a personal tragedy, an economic meltdown, or even a zombie attack.  Although for the latter two scenarios, guns and canned soups might be better than cash.

And, now a question: I can’t be the first one to have thought of these fuses.  Are these concepts floating around under different names?

Comments

[Dean Weber]

Great suggestions. I can't say that I am happying at my cursory fuse estimations. Fuse 1 has hit 0 months for the first time in my life. Fuse 2 obviously is at 0 as well. Lastly Fuse 3 I'm too frightened to even calculate. The recent stock meltdown and mortgage mess have wiped out a lot of my value. Why does this have to happen at such a bad economic time? Oh, I guess that's why it's bad. This has to be going on with many others as well. Time to start pinching all the pennies and building up liquid assets as quickly as possible.

[BrianM]

Investment people usually recommend that the second fuse be 6-12 months. I forget which term they commonly use for it. (Interestingly, I seem to remember 12 months being more common back in the day while 6 has been more common this decade - possibly because recent recessions have been mild enough that 6 months is thought enough to get a job?)

Why does the Armageddon scenario include liquid funds in the market (retirement savings, presumably in stocks)? Why not 10% of their value, as was (I believe) the low point of the DJIA in the 20's-30's crash?

Why include your house? I don't see a scenario where you could apply its value to monthly expenses. My family could pay off the remaining balance easily, but we'd keep it and live in it. People seriously underwater would likely walk away from their house - it wouldn't be an asset. For people in the middle, the house would be part of their monthly expense, as it is now - practically, another form of rent.

[Dan]

Your second scenario is what is recommended that you keep awareness of, and you should keep an emergency fund of 6 to 12 months for it.

In your third scenario, money doesn't really matter. In failed economies, staples and commodities become more important. A pair of levi's is better than a bar of gold.

[Chris Harbert]

Plenty of financial advisers recommend having an emergency fund, but this is the first time I've seen it represented as three different numbers. It's a neat way to think about it.

I have a fourth fuse: my camping food/gear. I must really be a pessimist... :)

[Jason Yip]

Regarding zombie attacks, remember that axes and swords don't run out of ammo.