Your financial exposure is the risk you face based on your financial position, including your investments, debts, savings and insurance. This helps you plan for emergencies like illness, injury or disability.
When you’re investing, you want to reduce your financial exposure as much as possible. The same applies with your general finances—to build a sound financial bedrock, you want to have as little financial exposure as possible.
The equation for calculating your financial exposure is simple:
- How much money you need - how much money you have access to = your financial exposure
How much money you need
It’s hard to know exactly how much money you’ll need if a health emergency comes up and you’re no longer able to work, but with a little estimation, you can get pretty close.
First, identify different scenarios: such as getting into an accident, being diagnosed with a critical illness and/or becoming unable to work for health reasons.
Now, think about how likely this situation is. Are there certain health conditions that run in your family? Do you have a high-risk job or high-risk hobbies? Remember that things like car accidents and heart attacks, which you may not have a particular risk factor, probably happen more often than you think.
Most of these situations come with either increased expenses, loss of income, or both. For each situation, consider which one would apply. Would you be unable to work and therefore lose your income? In that case, you’d need income replacement.
Would you have to undergo expensive medical treatment and therefore be facing increased expenses? And would your expenses be one-off or ongoing?
For example, let’s say you get into an accident and sustain serious injuries that require hospitalisation. You can’t work for several months, but you’re expected to make a full recovery eventually. In this case, you’d probably face some one-off expenses for hospital bills, medicine and possibly equipment to help you recover. You’d also need income replacement. But eventually, you’d be able to return to work.
On the other hand, if you were diagnosed with a critical illness like cancer or heart failure, you’d face repeated expenses for ongoing treatment, and you’d likely need income replacement for a much longer period of time.
One-off expenses: lump sum
You should be able to cover one-off expenses with a lump sum. So, for each one-off expense you might face in an emergency health situation, try to estimate the lump sum required. For example, if you became permanently unable to work, how much money would you need to pay off all your existing debts?
Here are some examples of one-off expenses you might face:
- Debts: if you can no longer work, you’ll need a lump sum to pay off your debts
- Medical expenses: while health insurance may cover some of these, you’ll likely still have to pay part out of pocket
- Home and vehicle alterations: if you become disabled, you may need to alter your home and/or vehicles to add ramps, handle-bars and other equipment
- Funeral expenses: no one likes to think about this, but if something happens to you, your family will have to pay funeral expenses, which can be costly
- Estate administration: if something happens to you, your family may need legal expertise to finalise your estate
Ongoing expenses: annual amount
Ongoing expenses are trickier to calculate. For these, you’ll need to think about how much each expense would be per year, and for how many years you would need to pay it. For example, if you need to cover the cost of your children’s schooling, how much is tuition per year and how many years would they be in school?
Here are some examples of ongoing expenses you might face:
- Living expenses: base these on your current living expenses
- Medical expenses: again, your health insurance may not cover all of these
- Children’s educational costs: this can be hard to estimate if your children aren’t in school yet, remember to vary it depending on your preference for public or private school
- Childcare costs: if you’re unable to work and your partner has to work in your place, you may need to pay for childcare
- Domestic help: if you have a disability, you may need in-home help
Add up these expenses for each scenario and you should have a rough idea of how much money you’ll need in an emergency situation.
How much money you have access to
This part is easier, because you should know how much money you have access to. Remember to include:
- Cash
- Savings
- Shares
- Property
- Insurance
Of course, this may not be an exact picture either, because your finances will be in a slightly different place several years from now, and there’s no knowing when a health emergency might strike. Your investments may increase significantly, leaving you with much more money than you have now, or you may get a pay raise before then and be able to set more aside.
But to be on the safe side, use what you have now. Add up all your current savings, income and investments, and don’t forget about any insurance payouts you may receive. For example, in the event of your death, your family should receive life insurance.
Putting it all together
Now, take the two amounts and plug them into the equation:
- How much money you need - how much money you have access to = your financial exposure
The final amount represents your financial exposure. If it’s a negative number, that means you have a surplus. In other words, you have access to more money than you’d need, so you’re in a pretty good spot if an emergency comes up.
If it’s positive (and it will be for most people), that’s the amount of money you’d need to come up with if you lost your source of income due to a health emergency.
Now that you know your financial exposure, you have two options in case of an emergency:
- Rely on your friends and family and hope for the best
- Transfer your financial exposure to an insurer (a.k.a., buy insurance)
Learn more about purchasing insurance for possible emergencies.
