DEALING WITH A FINANCIAL CRISIS
The recent Coronavirus pandemic has left us all feeling financially vulnerable, no matter what our situation. This article aims to provide some practical support with how to deal with a financial emergency. We take you through recommended steps if you find yourself in financial difficulty. We also examine what you should do about falling investment values during a financial emergency.
You can also find specific guidance on help for the employed, self-employed and businesses.
Key topics covered in this article
Play the first video below to listen to Dan Woodruff appearing on BBC Radio Essex where he discusses with Ian Wyatt the financial difficulties that have been brought on my the coronavirus, and ways to deal with them. The second video below features Dan Woodruff appearing on ITV Anglia discussing Coronavirus and the effect on pensions.
What is a financial emergency?
A financial emergency is any situation that puts you under significant financial strain. The current Coronavirus pandemic is obviously an event that it putting us all under significant financial strain. Many people will lose their income during this period, so hopefully some of the points raised below will help you to put together a practical response.
Examples of a financial emergency
Give each of the situations below some thought. How would you prepare for the financial strain that this might put you under?
- A shock to the financial system
From time to time there are occasional serious, even global financial shocks. The current Coronavirus is one such global event. This has caused most Governments to significantly restrict usual economic activity. The result has been uncertainty for employees, the self-employed, and business owners. - Investment downturns
If you have money invested, perhaps in the stock market or property, then you should expect occasional, temporary downturns in value. How you react in such situations will have a major impact on your long-term plans. - Losing your job
Even in normal economic periods, you may lose your income if your employer runs into financial difficulty, or no longer needs your role. What would you do if your employed income suddenly ceases? - Serious illness
If you are too ill to be able to work, then you are likely to lose your source of income. Your employer may pay you some sick pay initially, but what will you do when this inevitably stops? - Death of a partner
Apart from the personal tragedy of the loss of a partner, you will probably suffer some short-term, and possibly long-term financial strain as a result. How would you, or your family cope in this situation? - Other emergency situations
There can be many examples of short-term financial emergencies. How would you cope financially if any happen to you?- Your car breaks down
- Your home needs unexpected repairs
- You get an unplanned tax bill
- You get stranded abroad while on holiday
How savings help with a financial emergency
Probably the best way to see yourself through a financial emergency is to have appropriate levels of savings. If you have money available in cash, you can use this to pay for the unexpected expenses associated with the financial emergency. There will inevitably be a point where your savings become exhausted. The right amount of savings is a complex balance between short-term access to money should you need it, and longer-term growth.
- No savings
The biggest problem comes from not having enough savings to cope with an emergency. If you are in this situation, you will need to take drastic action with your spending (see below). Not having savings means that if you suddenly need access to cash you will either need to spend less, access longer-term savings, or borrow money. None of these solutions are ideal, but may become necessary. - Too much savings
Clearly , having savings will help you to continue as usual throughout the financial emergency. There is a danger to having too much in savings, as this money tends to grow very slowly. However, having more savings than you need is obviously better than not having enough. - Not enough savings
If you do not have enough savings then you will find yourself running out sooner rather than later. You may find that you have to take difficult decisions whether to adjust your spending, access longer-term accounts, or borrow.
What level of savings is ideal?
Obviously, if you are dealing with a financial crisis now, then the right level of savings is not top of your mind. However, hopefully you will see the back of this crisis and you can later build up cash to help you to deal with the next financial emergency.
An emergency fund
An emergency fund should have at least 3-6 months variable expenses in an instant access account. Take a look at your budget, and establish what is guaranteed income, and which income might be lost in a financial emergency. For example, guaranteed income might be from a fixed pension like the State pension, or a pension annuity. Non-guaranteed income might be from employment, self-employment, or investments. If you know what your typical spending is for a month or a year then you can deduct any income that you know is guaranteed. Anything that is left over is at risk should a financial disaster strike you.
Example:
John spends £2,000 per month on average. He also receives £700 per month from the state pension, and £1,300 per month from his work. John’s emergency fund should be built around 3-6 times his variable spending that is not covered by his guaranteed income. Therefore, the minimum should be £3,900 to £7,800.
If John had been made redundant as a result of the Coronavirus then he could use this emergency fund to pay for his usual expenses for 3-6 months while he looks for new work.
Planned expenditure
Add to your emergency fund any additional planned lump sum spending. For example:
- Tax bills
- Holidays
- New car
- Home improvements
If John had committed to work on his house costing £10,000, then he should have put this aside before beginning the work.
Taking variable income from investments
If you are taking variable income from long-term investments such as pensions, you could find that this income drops if the investment values fall. If you instead continue to withdraw from the investments at the usual rate this may severely reduce your investment capital while the values have fallen. As a general rule of thumb we tend to advise our clients to set aside up to 2 years’ variable income where they are taking income from investments that change value. This allows them time to continue with the planned withdrawals even when markets fall (which they should expect every 5-7 years). A typical market downturn might last 1-2 years. The plan would be to restore the cash balance once capital values improve. Of course, no financial crisis is standard, so even this fund can be depleted. However, it is a necessary practical compromise between short-term income being available, and long-term capital growth for your investments.
If John’s income comes partly from his personal pension plan, which is invested, then he would be glad to have 2 years’ variable income set aside. He could continue to withdraw from his pension knowing that he does not have to take dramatic action in the short term.
Changes to your budget in a financial emergency
If you find yourself in financial difficulty the first thing you should do is assess your budget.
Take a sheet of paper, or put this in a spreadsheet. List all of your income, and all of your expenses. Your income may have stopped, or you may have different sources of income that continue even through the crisis.
Once you have this data, you can clearly see if there is a surplus of income over expenses, or more likely a deficit (you are spending more than you are bringing in).
What is the deficit of spending after allowing for expected income?
How much savings are available?
If you have emergency savings then now might be the time to start to access these savings. In our example above, John’s emergency fund might permit him breathing space of 3-6 months without having to adjust his lifestyle in any way.
If you have savings, how long will they last if you make no further changes to your budget?
Will the emergency reduce spending?
Bizarrely, some emergencies decrease your spending even while your income ceases. For example, during the Coronavirus pandemic governments are locking down usual society. During this time, you may find that you are unable to spend money in the usual ways. Yes, you will continue to spend money on food and essentials. However, you are unlikely to spend money on discretionary items like eating out.
You may be able to adjust your budget for lower discretionary spending while the crisis lasts.
Cutting back on non-essential spending
If your budget is in deficit then you may need to take further action.
There are certain items of spending that will need to continue such as food, housing, utilities etc.
There are other spending items that can be ceased, such as gym membership, clubs, subscriptions, cleaners etc.
Look at your normal monthly spending and work out what you can do to cut back, possibly temporarily.
Drastic measures
If you still find that your spending is in deficit, even after cutting back on non-essential items, the some drastic measures might be needed:
- More income
One solution could be to generate additional income elsewhere. You may find that your employment has stopped, but there might be other opportunities. For example, during the Coronavirus crisis many sectors have stopped employment (pubs, restaurants, gyms etc). However, other sectors need more people, such as delivery companies and supermarkets. If you are nimble, you might be able to top up your income from elsewhere. - State support
Governments are doing what they can to support the employed, self-employed, and business during the Coronavirus crisis. You may be entitled to some support, so see below for more details. Of course, if your income has ceased, you should be entitled to apply for state benefits to help you to cope. - Debt holidays
Many loan providers will be supportive during a financial emergency, as the alternative might be for you to default on the loan. If you have any credit you should speak to your product provider to see if you can take a temporary payment holiday. This could apply to mortgage, loans, and credit cards, depending on the bank. The debt holiday might start at 3 months, and could help you to put off making payments during this period. Bear in mind that the debt and the payments will still apply, so any deferred payments will be added to the debt, either extending the term, or increasing the payments once the deferral period is over. You should also check that your credit rating is not affected. It is important not to just cancel your direct debit – speak to your provider first, or your credit rating will be affected. - Speak to suppliers
You should discuss your situation with any significant suppliers you have. For example, if you are renting you may get some understanding from your landlord, and no evictions can take place without 3 months’ notice. Larger companies and counciles are used to dealing with people who are in financial difficulty, so they may be in a position to offer a payment break, or to reduce services for a short period. In addition, HMRC is being understanding at present, so you may be able to put off tax bills. If any planned flights are cancelled you are entitled to a refund, not just vouchers against future flights. Many hotel companies are offering extensions to their standard cancellation terms. - Accessing longer-term savings
You may have money available in longer-term savings like pensions or shares ISAs. It could be tempting to access this money, but of course doing this could impact your future plans. Effectively, spending the money now means that it might not be available later. Added to that, the crisis might have reduced asset values, meaning short-term withdrawals take an even bigger slice of the available money. If you have fixed rate bank accounts, many providers will allow you to access these savings without penalties during the Coronavirus crisis. - Debt
You may be tempted to put your deficit spending on a credit card or overdraft. This can only be a very short-term measure, and could lead to a terrible spiral of debt that lasts for years after the initial financial emergency is over. Avoid expensive short-term debt like credit cards and overdrafts if at all possible. During the Coronavirus crisis banks are being encouraged to provide interest-free overdrafts where requested, up to £500. 0% credit card deals are still on offer, but these may become restricted. - Family loans
If might be possible to borrow money from a family member to see you through the financial emergency. If that person has access to savings, this could be a much better option than expensive credit.
Work out how you might meet the budget deficit using a combination of these measures.
Other support
- MOT tests
The government has announced an extension to all tests due after 30th March, provided your vehicle remains roadworthy. - Insurance
If you are out of work due to illness related to the crisis, then income protection cover is likely to protect your income, after the initial deferred period. Critical illness cover is unlikely to pay out.
Investments in a financial emergency
If you have money invested in pensions, ISAs, or other accounts, you are probably concerned about falling values. This section deals with how we generally approach longer-term investments in a crisis.
Stock market volatility
In any long-term investment it is inevitable that you will occasionally suffer short-term, temporary falls in value. The next few months may test us all, but it will be important for you to make the sensible decisions necessary to ensure that your long-term financial security is not affected.
Stock markets have had a very difficult time in the last month, falling in value due to fears over economic impact of the Coronavirus. It is normal and understandable to be fearful when seeing these changes.
Should you change your investments?
The answer, is to try to ignore your understandable fears, and focus on the messages of the government. It is reassuring that the government is taking the necessary measures to see the economy through this period, and that they will do “whatever it takes” to allow business to continue.
If you have invested wisely, this money has been saved for the long term. If you stick to your investment strategy, it should work in your favour over the medium to long term. Any changes you make now might cause significant harm in your future as you will inevitably lock in losses.
Our client portfolios were growing nicely before the crisis, and recent falls have pulled these gains back. The result is not as bad as you might fear. Our quarterly valuation statements show short-term losses, but less than the UK stock market.
How should you approach temporary market declines?
Investments are volatile – they all go up and down in value. In the past, all stock market falls have proved to be a temporary drop as part of a general rise in value over the longer term.
Typically, stock markets temporarily fall in value by 10% or more about once a year on average. The last major fall was at the end of 2018, and the UK stock market rose significantly after that point.
Longer-term investment market falls happen regularly too. In the last 100 years, the average bear market saw a fall of 36%, but the average bull market saw a rise of 507%. The point is that we cannot avoid temporary declines, but calm and patience will see this situation turn around for you.
How would any temporary fall affect your lifestyle?
Setting up investments as we advise allows you to wait out any market declines. This is because you should have alternative strategies in place to cope with the fall in value.
Would any temporary fall in value could have an impact on your current or future standard of living?
If you do not currently rely on your investments for income then a temporary market decline is unlikely to be a major issue for you.
We advise all clients to have enough cash to be able to cope with short-term market falls; if you are taking an income from your investments you are likely to have a cash buffer of up to 2 years of variable income. This will allow you to wait out the temporary fall in value.
The illustration below shows how we approach this with many clients:
Diversification
Our clients spread their assets around a variety of different asset types, and geographical regions. You cannot predict ahead of time which assets will perform the best, or worst at any stage. This approach should work in your favour when markets fall in value.
Here are some figures to illustrate this point:
Looking at data to 1st April 2020:
- The UK stock market has temporarily fallen by 28.54% in 3 months, or 21.93% in 1 year
- Our Cautious model portfolio fell by 10.65% in 3 months, but by 1.91% over 1 year
- Our Moderate model portfolio fell by 17.13% in 3 months, but by 10.89% over 1 year.
This shows that you cannot avoid temporary market declines, whatever your investment strategy, but diversification can limit some market losses when stock markets fall in value. This is why it is important to keep cash separate from your investments, to allow you to cope at difficult periods.
Bear in mind that your own investments will have performed differently, based on your portfolio, the charges, income etc.
Expect a range of investment returns
Unfortunately investments do not perform in a nice linear way. You should expect a range of returns, which give a general average over time. See below, which illustrates this point:
This chart shows how the current performance of our model investments are still within normal parameters.
Do not attempt to time the market
Do not be tempted to pull your money out of the stock market just because it has fallen temporarily. Markets change very quickly, and it is impossible to know whether we are the top or bottom of the market. You are better off holding your nerve, and listening to your financial planner. Take sensible decisions for your long-term security, keep enough cash to cope with short-term needs, and try not pay too much attention to today’s values.
The information above shows this in practice. It shows the UK stock market over the past 20 years. The red shows the worst point of the stock market during that year, and the blue where it ended up had you just left your investments alone. In almost every year there was a significant temporary decline, but in 19 out of 20 years the position was better by the end of the year.
What we do know is that if you sell now, you will simply lock in those temporary losses, and you will miss the inevitable rally when it comes.
Support for employees
Job retention scheme (Furlough)
If your employer is unable to pay you, the state will pay wages up to 80% of your usual pay, to a maximum of £2,500 per month (this only includes basic salary, not commission). Your employer will notify you if they have chosen to use this scheme, and can top up your pay to the usual level while the crisis lasts. Your employer will continue to pay you if your job is furloughed, and you cannot do any work during this period. The scheme is intended to offer support for employees who were in employed on 28th February 2020. Your employer can reinstate you if you are eligible for the scheme but they had made you redundant. You will still pay income tax and National insurance. Your employer’s auto enrolment pension contributions will be covered by the state.
The scheme will apply for an initial period of 3 months. The money will be paid to your employer by the end of April, and will be backdated.
Find if you are eligible for the job retention scheme.
Statutory sick pay
You can claim any sick pay offered by your employer if you are unable to work due to Coronavirus illness, or self-isolation. The minimum you will get is Statutory Sick Pay at £94.25 per week, payable from day one of your illness. You can write your own isolation note to verify your condition during the Coronavirus period.
Read more about Statutory Sick Pay.
Parental leave
You are entitled to take time off work to look after your children during the Coronavirus crisis (perhaps because they are not at school). However, your employer does not have to pay you if you take time off for this reason. Speak to your employer, because they may offer to pay you, or allow you to take annual leave.
State benefits
If you are not eligible for the above schemes, then you should be entitled to state benefits. The number of claims has increased by a factor of 10 during the Coronavirus crisis. The government announced that they will increase universal credit and working tax credit by £20 for 1 year. A single claimant aged over 25 is entitled to receive £409.89 per month. You will not be required to attend appointments at the Job Centre, or medical assessments during the Coronavirus crisis. Universal credit claimants can get other benefits such as help with housing costs, or prescriptions.
Support for self-employed
Self-employment income support scheme
You can claim a taxable grant of up to 80% of your average monthly profits, for 3 months, to a maximum of £2,500 per month. This is taxable, and will not be paid until June. Payments will be backdated.
The scheme only applies to self-employed and partnerships. This does not apply to company directors of Limited Companies, or other employees. HMRC will contact you if they deem you to be eligible. You can only claim a grant if you have submitted a tax return in 2019/19, and only if your total profits for each eligible tax year averaged below £50,000 before tax. The data used to determine your average profits will be from the 2016/17, 2017/18 and 2019/19 tax years (where applicable). You can only receive a grant if your self-employment income is at least 50% of your overall income. Unfortunately, losses reported will also be taken into account.
Importantly, under the self-employment scheme you can keep working.
More about the self-employment income support scheme.
Deferral of self-assessment income tax payments
HMRC will accept a delay in your next payment on account, due July 2020. This will still need to be paid by January 2021.
IR35 has been delayed
If you are a consultant subject to the IR35 rules then these have been delayed for 1 year.
Other business support
Some self-employed or partnerships may be entitled to additional support designed for businesses. See below for details.
- Furlough scheme for any employees
- Business interruption loan
State benefits
If you are not eligible for the above schemes, then you should be entitled to state benefits. The number of claims has increased by a factor of 10 during the Coronavirus crisis. The government announced that they will increase universal credit and working tax credit by £20 for 1 year. A single claimant aged over 25 is entitled to receive £409.89 per month. You will not be required to attend appointments at the Job Centre, or medical assessments during the Coronavirus crisis. Universal credit claimants can get other benefits such as help with housing costs, or prescriptions.
Support for businesses
There are a variety of measures designed to help businesses with the Coronavirus measures.
Job retention scheme (Furlough)
This scheme will pay up to 80% of earnings for employees up to £2,500 per month, plus employer National Insurance and pension auto enrolment contributions. Any employees in work on the 28th of February are eligible for the scheme, and you can reinstate any employees who were made redundant since that date. Workers cannot perform their usual duties if furloughed. Payments are due to be made by the end of April, but will be backdated to the start of March.
The scheme has not yet been made live, but in the meantime you will need to designate employees as furloughed, and will have to register them online once the portal is set up.
More about the job retention scheme.
Business interruption loans
This scheme applies to smaller businesses that require access to various forms of finance, offered by over 40 banks and financial institutions. The government will cover interest payments for a 12-month period. You will need to apply via your bank on commercial terms, and subject to a risk assessment of your business finances.
Find out more about business interruption loans.
Business rates holiday
Small businesses entitled to small business rates relief will have this scheme automatically extended for another year.
In addition, businesses in the retail, hospitality and leisure sectors will also have business rates waived, even if the business is larger.
Nurseries will also have business rates waived.
Find out more about business rates holidays.
Cash grant for retail, hospitality and leisure
Businesses in eligible sectors will be entitled to a cash grant of up to £25,000 per property. Properties are eligible if they have a rateable value below £51,000.
Find out more about the cash grant for retail, hospitality and leisure.
Small business grant funding
If your business is entitled to small business rates relief you will also automatically qualify for a cash grant of £10,000, paid by your Local Authority.
Find out more about small business grant funding.
Statutory sick pay rebate
The government will pay statutory sickpay for eligible employees claiming as a result of the Coronavirus, provided you employ fewer than 250 people. This will be paid as a rebate.
More about the statutory sick pay rebate.
HMRC time to pay for tax due
HMRC is being understanding about tax bills due by businesses during the Coronavirus crisis. Contact HMRC to find out how to delay payments of tax due by your business.
Find out more about the HMRC time to pay initiative.
VAT deferral
You can choose to defer VAT due between 20th March and 30th June.
For further reading, The Chartered Institute of Securities & Investments (CISI) have created some informative guides which are aimed at anyone employed, self-employed or owners of a business.
Click the links below to read the guides in full.
Employed: https://t.co/rM5hLJ3BqA
Self-employed or business owners: https://t.co/3bRAhqBlTU
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About Dan Woodruff
Certified Financial Planner & Chartered Wealth Manager at Woodruff Financial Planning
Financial Planning helps you to navigate and anticipate significant life changes. I want to help you to ensure your money is managed wisely to give you the financial security that will fund the future and lifestyle that is important to you.