Last month I broke a simple financial rule I follow regarding warranties and insurance. The purpose of any Insurance or warranties is to transfer catastrophic risk that you can not afford to bear.
Follow the Rules
If you follow rule 1 of our financial planning system, you will set aside an emergency fund equal to about 3 months of your monthly expenses (in more volatile income jobs like sales this might be 6 months to 12 months), but no matter your job the 1st bucket to fill up is an emergency fund.
This small savings or money market account will pay off in a variety of ways, but one of the first is that it allows you to confidently increase your deductibles to much larger amounts ($5,0000 , 1%, etc) which will decrease the cost of your insurance premiums. Having adequate reserves will also allow you to avoid all of the warranties and bogus protection plans that are pitched at you after every product you purchase.
We advise our clients to plan for the most likely outcome. Generally warranties and protection plans are huge money makers for retailers and should be avoided as long as you have enough liquidity to replace the item in the unlikely event it is damaged or lost.
We recommend that every client have a size limit. Any item less than that limit (no matter how good a deal the protection), is still not worth it the time and energy it would take to process a claim (my number is $10,000–Anything less than that we don’t even consider it) as my time and hassle factor are not worth it.
This size of this limit number should align with your cash flow and budget and will likely rise with your net worth.
As a young adult starting out your number might be $2500 or $5000 but as your savings increase, we would recommend you continue to raise this size limit to align the cost of your time and increasing liquidity.
We All Fail Sometimes
Here’s a recent example: I switched phones back to AT&T and the sales guy in the office was very slick. I resisted and resisted and then he found a weakness and pounced and convinced me to buy the insurance for a few months as it was going to be less expensive than the activations I was having to pay. Sure enough I had a screen crack and I went to fix it and I could not find my receipt and I wasted at least 2 hours, but worse than the time it aggravated me (which is why I’m telling you about it), so stay strong avoid small warranties opting to only pay for insurances on huge catastrophic losses, and in the long run you will be better off because of it.