At a glance

  • Find stress management strategies; focus on how to move forward.
  • Minimize tax consequences when drawing from investments.
  • Switch to a crisis-mode budget temporarily.
  • Rebuild your finances so they’re stronger in the future.

If you’re facing a tough financial challenge, you’re not alone. Many of us face money struggles at some point in our lives—a variety of factors like a market downturn or a change in your health can trigger these struggles.

Maybe you lost your job, made an investment that didn’t work out, or encountered a large, unexpected expense. Or maybe you’re struggling to pay off student debt or medical bills.

Whatever the challenge, you can put yourself in a better financial position. The sooner you start, the sooner you’ll get on track.

Here are 5 steps that can help you manage a financial shock.

Step 1. Control your thoughts

Chuck Riley
Chuck Riley, Senior Financial Advisor,
Vanguard Personal Advisor Services

Before tackling your financial details, it’s important to get in the right frame of mind. That means curbing stress by focusing on solutions.

“Stress is the enemy of good decisions,” said Chuck Riley, a senior financial advisor with Vanguard Personal Advisor Services®.

Coping with financial stress isn’t easy. But there are proven strategies that can help. Here are a few to consider:

 

  • Write it down. This trick might feel silly, but it works: Write down your problem using the third-person point of view. For example: “She lost her job; here’s what she can consider.” Or “He owes X amount; here’s how he can pay it off.” This exercise can help you gain perspective and identify potential next steps objectively.
  • Focus on today. Stop replaying how you could have avoided financial problems. Thinking too much about the past won’t change the present. Instead, focus on what you can do right now to improve your situation.
  • Take action. Staying busy can help you focus on the present. You’ve identified potential next steps. Now focus on accomplishing at least one thing a day to make progress toward your goal. For example, if your goal is to find a new job, add updating your LinkedIn profile or reaching out to an industry colleague to your to-do list.

Step 2. Tap your assets in the right order

Depending on your personal situation, you may need to withdraw from your savings or retirement accounts.

If you’re age 59½ or older, you may have more options because you can draw on your retirement accounts without paying fees and penalties. However, if you’re not yet eligible for retirement distributions, you can minimize fees and penalties by withdrawing from your accounts in the following order:

  1. Emergency fund. If you have an emergency fund, now’s the time to use it.
  2. Taxable (nonretirement) investments. If you have nonretirement accounts with stocks, bonds, or mutual funds, consider drawing from them next. If you’ve held the investment for a year or less, you’ll have to pay ordinary income tax on the withdrawal. Investments you’ve held for more than a year are subject to long-term capital gains tax, which is 0%, 15%, or 20%, depending on your taxable income.
  3. Roth IRA contributions. Roth IRAs give you more flexibility than other types of retirement accounts because you can withdraw contributions anytime. But don’t take out more than you put in—earnings are subject to early withdrawal penalties.
  4. Loan from a 401(k). You may be eligible to borrow from your retirement plan. However, loans are subject to your individual plan rules, so you’ll have to check with your plan administrator to find out how much you can borrow. And there are downsides. You have to pay back the loan within a certain period. If you don’t, you’ll have to pay taxes on the entire loan amount. In addition, if you leave your job, you could be forced to pay back the loan sooner. Even if everything goes as planned, you’ll have to pay interest on the loan. And while you’ll be “paying yourself back,” you’ll be doing so with taxed earnings.
  5. Withdrawal from an IRA or a 401(k). If eligible, you can withdraw money from your account for a serious financial hardship and avoid paying penalties. For example, you can use hardship withdrawals to pay for unreimbursed medical expenses, the purchase of a principal residence, and payments made to avoid foreclosure on a principal residence.
  6. Unsecured credit, such as credit card debt. Be careful when taking on high-interest debt—the power of compounding interest will work against you. Your debt can grow and snowball quickly. That can add years to the time it takes to pay it back, which can make it more difficult to recover from a financial shock.

In addition to drawing on your savings, it’s a good idea to limit the amount of money you need by cutting your spending.

Hardship withdrawals

Roth distribution rules

Step 3: Cut spending temporarily

If you’re struggling financially, cutting your spending is a critical step. In some cases, you may need to make drastic changes to your monthly expenses.

“People often fall into the trap of thinking they can maintain their current lifestyle and still recover financially,” Riley said. “When you have a severe financial setback, you have to make substantial changes. If you don’t, it’s going to take you longer and cost you more to get back to where you were.”

If you don’t already have a budget, it’s time to create one. That means tracking every expense you have and deciding whether it’s necessary. Depending on your situation, you may want to consider an extreme “crisis mode” budget, focusing on the following priorities:

  • Housing.
  • Food.
  • Utilities.
  • Transportation.

“Concentrate on the big expenses you need to keep,” Riley said. “Everything else can wait.”

Strategies for living on a bare-bones budget

Living on a budget is one of the best tools you have for weathering financial problems. But it’s not easy or fun. You may need to cut the cable, cancel a vacation, or put nonessential shopping on hold.

Here are some strategies that can make it easier:

  • Remember, it’s temporary. Your bare-bones budget isn’t permanent—it’s a short-term solution to get you back on your feet.
  • Seek peer support. Consider confiding in a friend or searching online to find a frugal support group.
  • Track your wins. One of the benefits of a budget is that you can see your progress. Meeting daily, weekly, or monthly goals can motivate you to keep going.
  • Change your approach to social media. Logging off social media can help you avoid comparing yourself with others.

When your financial situation improves, you won’t regret the steps you took to save money.

“The more sacrifices you make during this time, the better off you’ll be,” Riley said. “Proving you can be disciplined when the chips are down can give you the confidence to get back on track.”

Budget calculator

Step 4. Rebuild

Once you’ve become debt-free, found a job, or stabilized your finances, you can start to rebuild.

Here’s how to put yourself in a better spot than you were in before.

  • Save your crisis budget. After you switch to a livable budget, it’s a good idea to save a copy of your crisis budget to serve as inspiration for saving money in the future. In addition, you’ll have a backup plan if you ever need it. “You should be able to say, ‘If I lost my job, the first thing I’d do is cut cable. Then I’d cancel my gym membership. That will save X amount per month right away,’” Riley said.
  • Build an emergency fund. An emergency fund is key to a solid financial plan. A good general guideline is to save at least $2,000, which you can access easily if you face an unexpected onetime expense, such as a car repair or dental work. To prepare for an unexpected loss of income that can have a bigger financial impact, such as a layoff or a furlough, aim to save 3 to 6 months’ of living expenses. This money doesn’t have to be cash. In fact, it can be invested alongside your longer-term savings as long as it’s in an account that you can easily access, like a taxable account or Roth IRA.
  • Catch up on retirement contributions. If you’ve had a setback and used money from your retirement accounts, it’s important to build your savings back up. Under normal circumstances, we recommend saving 12% to 15% of your earnings for retirement. If you’re trying to make up for lost time, consider boosting the percentage you save (at least temporarily). Just be careful not to exceed the annual contribution limit.

Building an emergency fund

Vanguard money market accounts

Step 5. Stay focused on your new goals

Digging your way out of a tough financial spot often takes time. You might need to work for months or years to reach your goals. That’s why it’s important to create a new plan and stick to it.

Here are few strategies to stay on track:

  • Reset your goals and expectations. Depending on your finances, you may have to wait to renovate your home or skip a vacation. Or you may have to live in a smaller house or increase your planned retirement age. You might exceed your new goals. But it’s okay if you don’t.
  • Build in “you” time. Many people have trouble enjoying life when they’re dealing with stress. Force yourself to forget about your finances for a while. Focus on the aspects of life that make you happy instead.
  • Count your wins. Did you pay off a credit card? Get a new job? Go ahead and celebrate―just don’t throw your budget off track. As you make progress, take time to reflect on where you started and how far you’ve come.


Notes:

All investing is subject to risk, including the possible loss of the money you invest.

We recommend that you consult a tax or financial advisor about your individual situation.

Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company.

The services provided to clients who elect to receive ongoing advice will vary based upon the amount of assets in a portfolio. Please review the Vanguard Personal Advisor Services Brochure for important details about the service, including its asset-based service levels and fee breakpoints.