Future Focus: What would happen if your income stopped tomorrow?
How a break in cashflow impacts us all differently.
I recently listened to a podcast by Fear & Greed where they discussed the process of being made redundant – something that the podcast hosts had both experienced. This is a scenario I think about a good deal.
This should come as no surprise for those who have read Invest Your Way, the book I wrote with Mark. I am naturally conservative financially. Like all people, my experiences have shaped my relationship with money and I will always instinctively lean towards certainty. Some people connote risk with opportunity, but I tend to focus more on the risk side of the equation.
Investing is an artificial contortion of my natural tendencies. If I did what came naturally to me, I would be saving all of my money where I can see it and access it immediately.
Part of my anxiety around money manifests itself in thinking about what would happen if I lost my income. This has been exacerbated by knowing several people who have experienced redundancy. I should take comfort in the fact that they are all again employed, but that thought rarely brings me comfort.
If you don’t spend your time thinking about the possibility of losing your income tomorrow you can benefit from the scenarios that have played out in my head. It sounds like a simple question, but most people avoid answering it honestly.
Not because losing your income at least temporarily is unlikely, but because it forces a confrontation with the fine balance of many financial lives. There is a natural tendency to think of income as something stable and continuous. It arrives, it gets allocated, and life moves forward. Beneath this routine is an uncomfortable dependency on the continuity of a pay check.
A break in cashflow can see the rapid collapse of this finely balanced system. Here is how it may actually go.
The first shock
The immediate impact of income stopping is rarely dramatic in a visible sense. There’s no sudden collapse. It is quiet but confronting as bills continue to arrive and direct debits are deducted. Rent, mortgage repayments, utilities, insurance, childcare, subscriptions. Nothing pauses to reflect your new situation. Most people discover very quickly that their financial system is designed for continuity without any interruption.
I often think about how long I can go without additional income. That is where my emergency fund comes in and I know I have 4 months. An emergency fund allows you time to think, adjust and avoid decisions made under pressure. Without that buffer, the choices are usually liquidating assets or turning to credit. Both make a difficult situation worse.
The first month
If income doesn’t return quickly, behaviour will need to shift. The first adjustments are to discretionary spending – subscriptions are paused, investments aren’t topped up and travel plans are cancelled. Some people realise their lifestyle may be largely non-essential while still being habitual. This can be challenging mentally as you give up things that have become central to your life.
As time passes the pressure starts to build from fixed costs. Housing, debt repayments, schooling, and essential household commitments do not flex easily. Financial stress starts to rise, particularly when free time increases.
I often reference action bias when it comes to investing. It is the feeling that you need to act to be productive or in response to stress. This rarely benefits a long-term investor. When you have lost your source of income it is often combined with lots of spare time. This lack of activity can increase financial stress.
At this stage, households start shifting financial structures in response to fixed costs - present and future. They typically take one or more of the following actions:
- Negotiating payment arrangements with lenders or service providers
- Drawing down savings more deliberately
- Using credit as a bridging mechanism
- Reassessing what is truly non-negotiable in their budget
Three months
If income disruption extends beyond a few months, most people start falling into three broad positions:
- Those that have built meaningful liquidity buffers
This is the best position in a bad situation. It provides time to make good decisions about the next steps. You may have cash savings, offset accounts or liquid investments which provide the opportunity to act strategically.
- Those with limited buffers but access to credit or investments
This is not ideal but short-term disruptions can be managed. Long-term goals may have to be sacrificed, and the opportunity cost may be high depending on the investments that are liquidated. This may result in tax consequences that need to be managed in the future.
I’ve written an article on the order in which individuals should liquidate their assets here.
- Those with neither
This is acute financial pressure. Decisions are often driven by urgency and desperation rather than optimisation. Being in this position may cause long-term financial damage.
My vulnerability
I undertook a stress testing exercise of my financial position and how long I would last. I wanted to conduct this exercise twice- considering a scenario where my husband keeps his income, and a situation where he doesn’t.
One insight from this exercise is financial vulnerability is rarely about my total spending, but instead about fixed commitments. I have accumulated several commitments that add rigidity to my financial position, including a mortgage, and the recurring housing costs that come with it. I have day-to-day essential living expenses that would have to continue.
My hesitation to spend money means that my discretionary spending is very lean. If my income were to stop, there are some superficial costs that I could cut back. I would be able to have some breathing room by halting investments. The source of my vulnerability is mainly housing costs and bills that create a baseline level of expenditure that is almost impossible to reduce.
My two scenarios with my husband had very different levels of resilience, and how long I could last before liquidating my investments which are designed to achieve my long-term goals.
Different life stages
I am in a very different situation to where I was early career. I am in a relatively niche industry and have specialised early in my career. This can make it harder to find a job with similar pay. This difficulty often increases as careers progress.
The impact of income ceasing is not uniform, and can change depending on career stage, household structure and the nature of work. Early career, I could easily replace my income 1:1 in most economic environments.
Early career
Lower fixed costs and typically fewer dependants often means a faster recovery. The key risk is lifestyle setting in too early, reducing future flexibility.
Mid-career
This is often where financial vulnerability is highest, even if it doesn’t feel that way. Higher fixed costs, mortgages, and family commitments coincide with peak income dependency. Replacement income may not match prior earnings, even if employment is found relatively quickly.
Later career
Experience is high, but the market for equivalent roles is often narrower. There is financial vulnerability here as people try to keep suitable employment until retirement. The risk is not unemployment; it is underemployment relative to previous income. This is where financial independence and reduced fixed costs become increasingly important.
Niche roles and specialised industries
In highly specialised fields, the issue is not employability but market depth. Income recovery can take longer simply because opportunities are fewer and more specific.
Self-employed and contractors For those that are self-employed or contractors, income interruption is not hypothetical, it is almost always part of the model. However, the risk intensifies when income ceases and it is unplanned, such as illness or injury, where both current income and the pipeline of future income can stop simultaneously. Here, resilience often requires larger buffers.
How I’ve prepared
Financial wellbeing is often framed as a function of how much you earn and invest. Equally important is ensuring you have a strong system in place when one assumption breaks.
Financial resilience is a priority for me. Once you have achieved a degree of financial independence, it is a scary to consider things going wrong.
It is a priority for me to always have a fully stocked emergency fund. I’ve also stress tested my situation and simulated what would happen if my income stopped. Do this by laying out your annual costs. I picked the most expensive part of the year to have my income stop to test my resilience.
I have enrolled in appropriate insurances. If I am somehow not eligible for my insurance cover, I’ve ordered my long-term investments first to last in terms of what will do the least damage to liquidate if my cash buffer was exhausted.
How long can you last?
This exercise is not supposed to increase anxiety, but to expose assumptions and have a plan that is not formed under stress when or if something happens.
Conducting this exercise may cause you to top up your emergency fund or consider whether you can still achieve long-term financial goals with an increased allocation to liquid assets. It may reaffirm that you have a strong plan if your income stopped tomorrow.
Preparation makes it more likely you can maintain your financial independence and do the least damage to your long-term financial future.
Invest Your Way
For the past five years, Mark and I have released a weekly podcast and written on morningstar.com.au to arm you with the tools to invest successfully. We’ve always strived to provide independent, thoughtful analysis, backed by the work of hundreds of researchers and professionals at Morningstar.
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