Personal Liability Risk: Protecting What You Already Have

Personal Liability Risk

Growth is a common theme in most of our lives. Whether it’s our career, our marriage, or our finances, we strive for progress and improvement. This is both healthy and positive.

However, sometimes it’s important to shift our focus away from growth and towards protecting what we’ve already achieved. This is a form of risk management and can be thought about it several different ways.

When it comes to protecting wealth, risk management often centers on investing and ensuring that your portfolio is allocated in such a way that you aren’t exposed to more risk than you have the ability, willingness, or need to take.

However, thoughtful risk management should consider many other exposures to risk as well.

Often, this means having the proper insurance. Other times, it means avoiding unnecessary risks altogether (e.g. allowing your 16-year old son or daughter to take the car out for a joy ride at 2am).

In a lot of cases, properly managing risk focuses on the specific decisions you make on a daily basis (e.g. not drinking and driving).

A key area of risk that in my experience is far too often overlooked or severely underestimated, is that of personal liability.

What is Personal Liability Risk?

You can be held personally liable for many different reasons. Typically this stems from injuring someone or damaging the property of others. The most common examples of this are an auto accident or an accident that takes place in your home. However, personal liability can arise from just about any incident that takes place in which you are found to be at fault.

Examples of Personal Liability Risk
Auto

  • Collision with another vehicle causing personal injury and/or property damage
  • Hitting a pedestrian
  • Accident causing non-vehicle damage to private or public property

Home

  • Contractor injures himself while working in your home
  • Neighbor slips and falls in your backyard
  • A tree on your property falls and damages the house next door

Slander or Libel

  • You leave a negative review about a business and are sued for libel
  • You get into a public battle on Facebook that turns ugly and results in a lawsuit

It’s also important to remember that physical injury and property damage are not the only examples of personal liability. Did you know that you can also be held responsible for the things that you say or write?

If you are found guilty of slander or libel, you could be on the hook for damages to the injured party’s reputation or brand. This particular risk has grown exponentially in recent years thanks to blogging, social media, and other forms of digital communication.

What is the Financial Risk?

Judgments awarded in personal injury cases regularly run up in to the hundreds of thousands of dollars. Depending on the facts and circumstances, it’s not uncommon to see awards in the millions. This is enough to put most of us in a really challenging financial position (to say the least).

However, it’s critical to remember that the financial risks of personal liability exist even if you are not ultimately found liable by a judge or jury. The reason is simple: In order to be found innocent, you first have to provide for your own defense. And as we all know lawyers are not cheap!

The cost of adequate defense in a personal liability case can easily amount to tens of thousands or even hundreds of thousands of dollars. As a result, even if you are never found to be at fault, you can still be put at severe financial risk while you work to clear your name.

How Does Personal Liability Risk Impact You?

Although it varies by state, you can generally expect that in the event that you are held personally liable for an incident, all of your non-retirement account assets are likely at risk of being used to pay damages.

Worse, it’s possible that a judge could garnish your wages in order to compensate the injured party. Although it may surprise you, it’s true. It is not at all unheard of for the party found liable to be on the hook for a sizeable percentage of their future income for a certain period of time.

How do We Protect Ourselves from Personal Liability?

The best way to protect yourself from personal liability risk is through proper insurance. Specifically, your auto and homeowners/renters insurance policies are designed to provide coverage from the most common incidents that could arise where you might be at fault.

Far too many drivers carry the absolute minimum liability insurance required by the state on their auto policies. Likewise, many homeowners and renters elect liability limits that are simply inadequate relative to their true needs.

Furthermore, most people would be well-served by supplementing their auto and homeowners/renters policy with an umbrella or excess liability insurance policy.

So how do you determine how much liability protection you actually need? Answering that question requires a thorough review of one’s specific facts and circumstances. However, such a review should at a minimum consider:

  • Your “at-risk assets” (those that are not protected by bankruptcy or creditor laws)
  • Your current and expected future income
  • Whether you have young or inexperienced drivers in your home
  • Whether your risk of personal liability is higher or lower than average given your lifestyle and occupation

If you don’t have a risk management plan in place or haven’t reviewed your liability insurance coverage recently, I highly recommend that you take the time to do it. If you work with a financial planner, this is a topic they should be speaking with you about. Your wealth and income depend on it!

Some Love for the Unloved Emergency Fund

Emergency Fund

Everyone knows that having an emergency fund is a good idea. Personal finance gurus from Dave Ramsey to Suze Orman shout from the tree tops about the benefits of socking cash away for a rainy day.

Most of the time, the discussion about an emergency fund centers around two factors. Namely, that an emergency fund:

  1. Prevents you from resorting to credit cards to make ends meet
  2. Greatly reduces the possibility of being forced to tap your retirement accounts

I think all reasonable people can agree that these points are absolutely correct and I hope the message is resonating with the public.

However, I don’t think the emergency fund gets enough love. The advantages of having a stockpile of liquid cash on hand go far beyond avoiding debt or keeping your retirement accounts intact.

In fact, there are significant economic benefits that an emergency fund provides that I would argue are often missed. In addition, these benefits should be added to the otherwise pitiful interest rates on cash these days in order to derive the true “yield” you are earning from your savings.

Often, the additional savings you might derive from these ancillary benefits could amount to more than your bank pays you in interest every year!

With that in mind, let’s take a look at four less obvious benefits of the unloved emergency fund:

1. An emergency fund increases your ability to take risk with your investments

Let’s assume for a second that you have $0 in savings outside of your retirement accounts. If you lost your job at the same time the market was in steep decline, you’d probably find yourself in a pretty difficult position.

Your day-to-day life would be greatly affected and you’d likely be forced to take withdrawals from your retirement accounts (thereby locking in losses and probably incurring taxes and penalties as well).

On the other hand, let’s say you have a solid emergency fund in place. This time your emergency fund steps in to provide for your living expenses until you find a new job and your retirement accounts remain untouched. Effectively, you’ve insulated your daily life from the volatility of the market.

In the first scenario, it would probably be foolish to invest 100% of your account in stocks since you might actually need the money well before retirement. However, assuming you had a long enough time horizon and could emotionally tolerate the ups and downs, it’s feasible that in the second scenario you could own an all equity portfolio.

Long story short, the protection that an emergency fund offers means that you might be able to increase your allocation to stocks in your retirement accounts *and thereby increase your long-term expected returns).

2. An emergency fund allows you to increase your insurance deductibles

I spend quite a bit of time reviewing the auto, homeowners, and renters insurance policies of my clients. My goal in doing so is to help them better understand their policies, make recommendations to provide greater protection, and to identify any gaps that may have been overlooked.

I’m also focused on strategies to help them save money on their premiums. One way to do this is by raising the deductibles on their policies.

Assuming the client has built up an emergency fund of at least six months of living expenses, they are in a great position to increase their deductibles, which can save them hundreds of dollars or more every year.

Often, we can then take this savings and apply it towards improving their coverage. For example, raising the deductible on an auto policy often generates enough savings to purchase umbrella coverage.

No matter how you slice it, an emergency fund gives you a lot of options when it comes to your property and casualty coverage.

3. An emergency fund gives you the flexibility to pursue new opportunities

If you’re like most people, you’ll probably experience a handful of instances during your lifetime that have the ability to completely change your trajectory.

It could be a new job half way across the country. It might be an opportunity to take time away from work to travel or to volunteer for a cause you really believe in. Maybe a friend approaches you about starting a company.

Whatever it is, it could be life changing in a very positive way. However, a lot of these opportunities require you to give up a steady paycheck for awhile.

With a solid emergency fund in place, you can consider the opportunity without worrying nearly as much about managing through the day-to-day.

Without one, you’re left wondering whether it’s worth it to raid your retirement account or take on a bunch of debt in order to pursue the opportunity.

4. An emergency fund might allow you to switch from a traditional health plan to a high-deductible plan

Lately, almost everyone has felt the effects of rising healthcare costs. It hasn’t been uncommon for insurance premiums to jump by 10%, 20%, or even 30% from one year to the next.

Likewise, employers are shifting more of the burden to employees by raising the amount you need to contribute towards your plan.

One option to help stem the impact of higher premiums is by choosing a high-deductible health plan (HDHP).

Keep in mind that every situation is different, but often the lower premiums combined with an employer’s contribution to a health savings account (HSA) can make an HDHP a big win.

That said, until you build up a sizable HSA balance (which in reality is a form of an emergency fund in and of itself), an HDHP probably isn’t a good idea unless you have cash available to pay for deductibles and co-insurance.

If you have your emergency fund built up, you could easily cover the larger out-of-pocket costs of an HDHP. This could mean thousands in savings on your premiums every year.

Closing Thoughts

The persistently low interest rate environment has caused many investors to second guess the wisdom of keeping a large emergency fund on hand.

However, if you fully leverage the power of your stockpile of cash, the ancillary benefits can outweigh the interest you might earn even if rates were much higher.

And just remember that even if you take your emergency fund for granted and don’t give it the love it deserves, it will always be there when you need it!

Predict or Prepare? How we Manage Uncertainty in Life and Money

Predict or Prepare? How we Manage Uncertainty in Life and Money

Generally speaking, there are two types of investors:

The first are investors who believe that they must do a better job forecasting the future than other investors in order to win. We’ll call this group the predictors.

The second group are investors who believe they should focus on what they can control, instead of trying to predict the future. They recognize that the future is uncertain and follow the age-old advice of “hope for the best, but be prepared for the worst.” We’ll call this group the preparers.

Let’s talk about the predictors for a second, as I would argue most investors are members of this group.

Predictors believe that the primary determinant of their success is the ability to predict the future.

In order to successfully grow their portfolio, for example, they feel that they must know where Apple’s stock price is headed or whether emerging markets are poised for growth.

Likewise, to avoid financial disaster, they believe that they must peer into the future and see the stock market train wreck before it happens. With this knowledge, they believe, they can move their portfolio to cash and sidestep the turmoil that uninformed investors will inevitably face.

In other words, as their name implies, this type of investor is in the business of predictions. Quite simply, they make decisions based on their best guesses about how future events will unfold.

Although it may surprise readers who know me, the objective of this post is not to argue whether or not predicting the future consistently is possible.

Smart investors know that even the best forecasters get it wrong more than half the time, but that is a topic for another day.

Rather, my question today is whether or not the behavior of making decisions based on predictions is consistent with other aspects of our lives.

In other words, do we generally take on a mentality of prediction or preparation in situations of uncertainty?

I would argue that in most instances where the future is unknown, human beings seek to prepare themselves for the uncertainty of the future by managing risks, as opposed to trying to predict the outcomes and then placing their bet.

Below are a few real-life examples that hopefully illustrate this point:

Seat belts

Do you make a prediction before you get in a car about whether or not you will get in an accident that day? Does that prediction determine whether or not you decide to wear your seat belt during the ride? I sure hope not!

Instead, because the inconvenience of wearing a seat belt is clearly outweighed by the protection it offers, we buckle up every time so that we are prepared in the event of an accident.

The consequences of a bad crash are simply too high to leave such an event to chance.

Insurance

Do you cancel your insurance policies during months you’re feeling safe and then reapply when you feel concerned about the safety of your family, your property, or your life? Of course not.

We purchase insurance and pay our premiums because we want to be prepared at all times if the unexpected happens.

We’re not willing to rely on our crystal ball when it comes to protecting our loved ones and our valuable assets.

Your wallet

When you look in your wallet, does it contain a single form of payment? For example, only one credit card or just cash? Doubtful.

More than likely, you carry some cash, a debit/ATM card, and a couple of credit cards. Whether you do it consciously or not, the reason you carry multiple forms of payment is so that you are prepared.

What if the store at all mall doesn’t take American Express? No problem I have my Visa.

What if the restaurant doesn’t take credit cards? No big deal. I’ve got cash.

Instead of trying to predict what your day is going to look like and then carrying only the forms of payment you think you’ll use that day in your wallet, you prepare for anything by keeping your wallet well-stocked.

For good measure, here is a short list of other life situations in which we are preparers (as opposed to predictors):

– Dressing in layers when hiking
– Keeping an emergency kit in your house and car
– Carrying a spare tire in the car
– Bringing extra batteries for the flash light on the camping trip
– Buying extra food for the party in case more people come
– Keeping back-up copies of important documents separate from the original
– Giving the neighbor an extra key in case you get locked out

What does this mean for investors?

As I said previously, the objective of this post is to think about how we deal with uncertainty in life and how that relates to investing.

Although the world will always be filled with predictions and forecasts, in many areas of our lives, we focus instead on preparation.

I would argue that investors would be well-served by taking a similar approach.

Instead of trying to predict what will happen in the market or whether interest rates are going to increase next year, you should develop a plan that incorporates a wide range of possible outcomes.

Such a plan should recognize that a 30% decline in the value of the stock market is well within the range of possible things that could happen.

Accordingly, as an investor, you should prepare by building a portfolio that is consistent with your willingness, ability, and need to take risk, but only take as much risk as you absolutely need to.

Likewise, it’s very possible that a single country could experience a protracted economic decline that would devastate investors whose entire portfolio consists of that country’s stocks.

For that reason, it is wise to prepare for that uncertainty by diversifying your portfolio around the world in both developed and emerging markets.

I could give a long list of examples, but the point is this:

As an investor, there are many things you can control and you would be wise to focus your attention on them.

For everything else, you should be aware of the likely outcome, the downside case, and the upside case. However, instead of placing your bets on one or the other, you should have a plan in place so you are well-prepared no matter what happens.