A Wake-Up Call Without the Trauma

Imagine a hypothetical guy who lives a responsible financial life. He’s focused on meeting his obligations, even though he doesn’t have a big cushion when it comes to his take-home pay. Things are tight. He’s not quite living paycheck-to-paycheck, but it’s close. Then one day, an external shock completely outside his control occurs, and it affects him negatively.

Through no fault of his own, he ends up missing a couple of bills. These missed payments hit his credit score, and it drops 50 points. What happens next might surprise you.

He uses this experience as a wake-up call. Things were painful in the short run, with limited access to credit. But a couple of years later, he’s ahead of where he started before the shock. In fact, he ends up in a better financial position than his peers who didn’t experience this event.

Though hypothetical, our story gets us really close to an interesting study conducted by Mark Garmaise at University of California, Los Angeles and Gabriel Natividad at Universidad de Piura. They wanted to know what happened to people living on the edge financially when they experienced an outside shock. To figure that out, they needed to isolate a group of people who had experienced a random, negative event to see how it affected them. They found one in Peru.

Why Peru? I’ll spare you the details, but the researchers found a good data set that included a very random and very negative currency risk. Through no fault of their own, this particular group experienced a shock.

What happened next looks a lot like our earlier story. The group used this shock as a wake-up call to improve their financial lives. The study found that people who went through this experience were less likely to have unpaid fines, taxes and government penalties than their peers who avoided the currency issue.

I found this outcome fascinating, and it made me wonder. Could we trigger our own wake-up call without experiencing the trauma of an actual shock? It’s sort of like a fire drill; while it’s impossible to simulate the actual experience, perhaps we could get close just by imagining ourselves in different situations. Here are three to get you started.

1. Pretend you don’t get your year-end bonus or your annual raise. Perhaps you’ve been lucky enough to get a raise or bonus or make a bit more money every year for the last few years. If you’re like me, you may have already spent that money, at least mentally. So what happens if you don’t get it? What impact would that have on your finances?

Or maybe you really have already spent the money on something like a new car. You had planned on the extra income to make the payments more manageable. What does this shock feel like? Will you have to give up something else to make the numbers work?

2. You have an adjustable-rate mortgage scheduled to reset in two years. Let’s say you have a $250,000 mortgage and your monthly payment is $1,054. Your current interest rate is 3 percent, and you plan on your new rate only going up by a little bit.

So you’re shocked to open your new statement and discover your rate has become 5 percent. That’s a difference of almost $300 per month on a $250,000 mortgage. What would that look like, and feel like, financially and emotionally? Maybe things are a little tight now, even at your current monthly payment. What happens when it goes up in the future?

3. Let’s say your quarterly investment report comes in the mail. It shows your long-term investment accounts are down 30 percent. It’s not impossible. How would you react? Are you prepared emotionally for the possibility? Would you need to rethink some long-term plans?

In all three examples, I’m not saying they will ever happen to you. But these outside shocks aren’t uncommon. In fact, I think they happen more often than we realize.

While it may be impossible to recreate the exact experience of a negative shock, try it. Sit down with your spouse, partner or friend and work through these examples and others. Then, write down what you learn.

Do things turn out O.K.? Do you need to make adjustments? Like most wake-up calls, this one is about figuring out what needs to happen without the pain of living through a real-life shock. After all, there’s no rule that says we have to fall into a hole to learn a lesson.

This commentary originally appeared October 5 on NYTimes.com

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© 2015, The BAM ALLIANCE

Carl Richards, CFP®

Carl Richards is the creator of the weekly Sketch Guy column in The New York Times and is a columnist for Morningstar Advisor. Carl has also been featured in The Wall Street Journal, Financial Planning, Marketplace Money, The Leonard Lopate Show, Oprah.com and Forbes.com. His simple but meaningful sketches served as the foundation for his first book, "The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money."

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