Carl Richards is a financial planner and author who has written extensively for the New York Times. He recently wrote:

“We do planning wrong.

It doesn’t matter what kind—financial, business, life… you name it.

Here’s how we typically plan:

1- We put a stake in the ground where we are today.

2- We put a stake in the ground where we want to be in the future.

3- We draw a straight line between the two stakes.”

His point is not that we shouldn’t draw that straight line to where we want to be, but that we have to be aware that our plans never work out exactly as we imagine. 

This is why it’s critical to build some flexibility into your financial plan. And as you might expect, this is a significant point of focus for us as we work with young families who oftentimes don’t know exactly what their long term goals are.

Here are 5 ways to build flexibility into your financial picture so that you are prepared for the unknown that life will throw your way.

Don’t Lock Yourself Into Large Fixed Expenses

Fixed expenses are by definition not flexible, so it’s best to keep these under control as much as possible. 

Homes and vehicles tend to be the biggest purchases we make that turn into fixed payments. So before making these big commitments, make sure they fit comfortably into your budget.

Build an Emergency Fund

An emergency fund gives you a source of cash for unexpected expenses. This helps keep you on track to meet your financial goals by allowing you to leave your long term savings in place should something pop up that was not factored into that straight line between where you are now and where you’re going.

Every family’s situation is different, but in general, we recommend keeping 3-6 months of money in a savings account for emergencies that may arise.

Tax Diversification

We typically talk about diversification in terms of investing in a broad range of stocks and bonds.

But when it comes to maintaining flexibility in your finances, it’s important to diversify where you are saving. There are three distinct tax buckets your savings can fall into – taxable (taxable brokerage accounts, savings accounts), tax deferred (traditional IRAs or 401(k)s), and tax free (Roth accounts, HSAs).

By saving into all three buckets, you maintain some control over how you are taxed when you withdraw the funds since all three are taxed in different ways:

Taxable accounts that have increased in value are taxed at capital gains tax rates if investments are held for longer than one year. But you pay taxes on dividends or other income while you hold the investment.

Tax deferred accounts are taxed at ordinary income tax rates (similar to your salary), but there are no taxes on income generated from the investments prior to withdrawing the funds.

Tax free accounts are not taxed at all assuming you meet the requirements of the account – for example, Roth IRA’s require the account to be open for 5 years before withdrawals are made, and HSAs require that you use the funds to pay for qualified medical expenses.

By diversifying the types of accounts you save into, you also give yourself flexibility in the timing of your withdrawals. With tax deferred and tax free accounts, there is typically a penalty for withdrawing funds before age 59 ½. Taxable accounts do not have a similar penalty, so they can be ideal if you plan to retire early or have other pre-retirement goals you are working toward.

Have Sufficient Insurance Coverage

Similar to having an emergency fund in place, having appropriate amounts of auto, homeowners, and umbrella insurance will ensure that you don’t need to dip into your savings if you need to make a claim.

Review these policies at least every few years and evaluate the amount of coverage you have. If the value of your home has increased significantly, assess whether the increases in your coverage (many policies automatically increase your coverage by a small percentage each year) have kept up with the increased cost to rebuild.

If you don’t have umbrella insurance, consider adding it. This insurance adds extra liability coverage for injuries or property damage you could be held accountable for. And typically it’s very inexpensive for the amount of coverage it provides.

Keep a Cash Flow Cushion

If you’re saving the minimum to meet your goals and spending the rest, you don’t leave yourself any room for error when that straight line to your goals gets a bit off track. 

Think back over the past year about the extra costs that came up that you hadn’t planned for and how these impact your ability to save the amount you want. Kids birthday parties, donations to friend’s charity fundraisers, an entire new wardrobe when your middle schooler shot up three inches overnight. These type of expenses can creep up and make a big dent in your ability to save for your goals if you don’t have extra room in your budget. 

Maybe you feel comfortable stretching things a little thin temporarily if you are on a career path with a clear route to a higher salary. But if you are already in your peak earning years, be wary of not leaving yourself that extra cushion.

Overall, we would all love to have a clear, defined path in life, especially when it comes to financial success. But the truth is that life happens. A bit of extra care while completing your financial planning can help allow you to stay on track despite the inevitable ups and downs of real life.

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

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Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.