Financial Physics – Part IV

The Safety Net

As mentioned in Part III, either we reinvent old ideas (Madonna) or come up with brand new ones. Either way, the market requires we constantly adjust. In this our last installment of financial physics let’s discuss the importance of preparing for change, especially the change you don’t want to happen.

I hate seeing bad things happen to good people but it is a fact of life we all have to deal with. When the unexpected finds us, it requires time and money to change our lives. This is not scientific, but it seems that it takes between 3 and 5 years to fully recover from the bad event. The detoxification and reset from a surprise does not happen overnight.

For example, the surprise lawsuit a friend received threatened to put him out of business. He was fighting a large company with seemingly unlimited resources to make his life miserable. Problems at the business quickly make it home because of their symbiotic existence. It took 3 years to wage the battle and of course a successful lawsuit leaves each party equally unhappy. His business survived because he fortunately had a large enough safety net to keep his lawyers interested long enough to persevere the onslaught. (Most lawyers turn against their clients when they run out of money.) Now he is back to rebuilding his safety net.

We created the Cash Flow Stress Test to simulate the worst case scenario – complete loss of all income. How long would your liquid, after-tax assets pay your bills? If it is less than 3 years, you are at much greater risk of not surviving the unexpected than someone with 5 years. The Cash Flow Stress Test does not have to imagine the event that might cause the problem; it only has to imagine the outcome. If you have enough after-tax assets to survive 5 years without income, it increases your ability to take risks, it creates more peace to live without fear and it helps you if the unthinkable happens.