Hi. I’m Kevin McKee from Thousandaire.com.
Last November, Daniel wrote about How to Use Personal Finance to Make Friends, which in his case was to steal money from a corporation and give it to a stranger in the store. Daniel is a great writer and a good guy, but we don’t always see eye-to-eye on things. This week, we have a little disagreement on Emergency Funds.
Daniel posted at my site why he thinks Investments and Credit Cards Are Not an Emergency Fund. I say having three-to-six months income sitting around in a 0% or low interest savings account is a big, fat waste of money.
I do truly believe it is essential to have enough money to live for three to six months if you lose your income or have a huge unexpected bill. You don’t want to let one incident ruin months or even years of financial planning and execution. So why don’t I recommend Daniel’s boring emergency fund?
Here is my three step process to covering your financial rear-end without a dedicated emergency fund.
- Have enough money in your checking account and liquid investments to cover yourself for 3-6 months (be willing to sell investments, even at a loss, in case of an emergency, or use a credit card or loan if necessary) and use those accounts as your emergency fund if necessary.
- Be a rock star at work and make yourself indispensable and always keep your resume updated in case you find yourself looking for work.
- Insure yourself against catastrophic situations that could ruin your finances,
My method is a bit more risky than keeping your emergency fund in cash, but with that risk comes the opportunity to substantially increase your net worth via the return on your investments. Why would anyone keep money in an account that returns 0-2% interest when it could be invested in the stock market where the average return is about 8%? The difference between 1% and 8% on a $10,000 balance is $700!
Sure, I could potentially lose money in the stock market. I could have bought at the top of the market in 2007 and sold at the bottom in 2008 and lost 50%. But I also could have bought at the bottom and sold this week and been up 90%. The fact is over a long period of time the stock market has always historically gone up. If you expect that to continue, then I recommend getting involved. Plus, if you do steps two and three correctly, the goal is that you would never even have to tap into this money if you did have an “emergency”.
The real keys to this plan are not losing your job or finding a new one quickly and insuring yourself against unexpected emergencies.
If you work your tail off and make yourself a valuable asset to your company, then you should have no trouble keeping your job or finding a new one if you find yourself unemployed. The most important part of this step is to be honest with yourself about your skills and performance. If you hate your job and just do the bare minimum of what your boss asks of you, then you better not believe you are indispensable. There’s no sense in adding the risk of a negative return on your investment if you are already at risk of losing your job and struggling to find a new one.
Finally, you most likely never have an outrageous unexpected bill if you have insurance to cover any catastrophic financial situations (medical, short and long term disability, auto, home owners or renters). If you have all the appropriate insurance, then keep enough to pay your deductible and invest the rest. I’d also recommend not touching very expensive, breakable stuff that isn’t yours.
By ensuring you are employed and that you don’t have to pay for catastrophic expenses, you dramatically reduce the need for an emergency fund and free up that money to invest at a higher return. Then if all else fails and you do need money, there is nothing stopping you from selling those investments and using that cash. If you’re still short on money at this point, then unless you lost a lot of money on your investments, you would have been out of Daniel’s boring emergency fund as well. At this point you can try to take out a loan or put expenses on a credit card.
Don’t waste your money on a boring, low interest emergency fund. If you aren’t putting your money to work for you, then you’re always going to be working for your money.
If you’re an exciting risk-taker and think I have the right idea, post a comment here and let me know. If you’re one of those lame savings account people, I encourage you to go to Daniel’s article and post a comment supporting his side over there. We’ll tally up the comments at the end of the week and see who wins. Daniel won the first debate (I think it was unanimous) so help me even up the score!
