Tag Archives: emergency fund

Don’t Waste Your Money on an Emergency Fund

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.

  1. 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.
  2. Be a rock star at work and make yourself indispensable and always keep your resume updated in case you find yourself looking for work.
  3. 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!

Mailbag: 5 Steps To Get Out Of Debt

I received this email from “Alan,” a 24 year old who was just hired after being unemployed for 8 months after graduating college.

I am in $15,000 of credit card debt and got a job that pays $60,000/year. I was living with friends without really paying rent and now that I’m moving out into the real world, I have no idea what to expect once I get there. I have to pay for rent, utilities, food, and car payments, I’m not sure how much I should set aside for debt, retirement, and savings. How should I allocate my funds?

Alan seems to be in a fairly similar position to me, although his credit card debt is likely accruing interest at a faster pace than my student loan is. I would recommend 5 steps to get started building savings and tackling the debt.

1. Track Expenses

Go right now and sign up at Mint.com. It’s hard to predict exactly how much you’ll spend on lunch with co-workers, fun, and other expenses. Don’t worry about creating a budget just yet, but be responsible with your purchases. Keep in mind that you’re in debt and are trying to get out.

2. Build $2,000 Emergency Fund

After paying the minimums on your credit card, throw everything else into an emergency fund. Some people suggest that $1,000 is enough to get started, but the truth is that $1,000 may not cover what you need. If something happened to your car or if your job doesn’t work out for some reason, this is what you’ll have to rely on. $2,000 should provide you enough of a cushion at the beginning, and after you have that much, keep contributing a small amount each month to give yourself more to fall back on. Every few months, check back on this emergency financial file and keep adding because as you work more, you’ll have higher expenses and will need a bigger cushion.

3. Build A Budget

Once you have an emergency fund, it’s time to see how much you can afford to throw at the debt. Use Mint to build a budget based on your expenses in the first 2 or 3 months, and cut out what you can. Stick to your budget and you’ll see the debt decrease.

4. Aggressively Pay Off Debt

Anything you have left over after expenses and what you put into the emergency fund, write a check to the credit card company. This number will fluctuate depending your living situation and city you live in, but more you pay now, the less you’ll pay overall. Imagine the feeling of being debt free!

5. Work Hard

While focusing on getting out of debt is great, keep in mind that it will be a slow process. Over time, the mound of debt you have will decrease slowly and surely, but it shouldn’t be all you think about. Focus on your job. Improve yourself, work hard, and get noticed. If the debt is gone but you don’t have a job, then you’ll be right back to where you started. The best thing you can do is to do you job well. Having that job will be much more valuable than the emergency fund.

For now, I am going to suggest passing on the retirement savings because the interest rates on your credit cards are likely higher than the rate of return you’d get in your retirement account. Once you have the debt taken care of, you can start pouring all that money you were using to pa off the debt and instead use it to build a healthy emergency savings account and retirement fund.

What other steps should Alan be taking to get out of debt?

If you have a question you’d like answered, please don’t hesitate to contact me!