Get your emergency fund before the emergency
September 16th, 2005 | by mbhunter |Heard of the 3- to 6-month emergency fund rule? That you should have enough cash or near-cash set aside for half a year’s expenses?
Liz Pulliam Weston’s article, The $0 Emergency Fund, discusses this wisdom.
First, she looks at the good side of our financial habits as Americans — almost half of us don’t have any credit card debt, most of us have some retirement savings, and only about a tenth of us are overextended with debt.
(I didn’t think that there was much good at all to be said about American consumer debt, but we’ll leave it at that. OK, so we’re not doing too badly there.)
She does go on to say, though, that we don’t really have much saved away for a rainy day — the cash needed to “tide over” a few months’ expenses.
The reasons?
- It takes a while. (Fair enough)
- We have credit card balances to pay off. (A good reason not to have a lot in savings — pay down the debt.)
- We don’t want to lose out on matching 401(k) contributions. (Also not a bad reason.)
- Cash doesn’t earn much interest (opportunity cost).
But despite the lack of a cash stockpile, that’s okay, she goes on to say, because the emergency fund doesn’t have to be cash. It can be lines of credit. So if your financial situation is “flexible” you’re all right.
I suppose this is a legitimate way to look at it. You can charge things for a little while, and maybe even carry the balance without paying it down for a while. It will cost you, but the option is there.
Until stuff happens to you, though, it’s hard to get motivated to get your act together. There’s no urgency. If you’re young, have a good paying job, and can make all of your payments, why bother paying them off and saving? It’s easy to think that way until you lose your job or get sick, then lose your stuff, your credit rating, and maybe your house. Then it’s too late. Just like if you’re young and 70 pounds overweight, why worry about your health? It may be too late when a heart attack rolls around. About half of the people who have heart attacks don’t survive the first one.
Ms. Pulliam Weston’s article offers options for an emergency fund if you don’t have cash. Fair enough. But I think that people should be motivated a little more than just getting a couple more credit cards and opening a HELOC. Here’s how I’d go about it. These don’t contradict the article; they just provide different emphasis:
- If you have credit card debt, pay it off ASAP. This reduces your monthly expenses should something bad happen, and it does indeed make no sense to earn interest at a few percent when you’re paying 10% or more on credit.
- Fund your retirement accounts. There is a cost to pulling stuff out of these prematurely, but it’s better than acquiring debt.
- Increase and shield your income streams. Can you get a second job or start a side business? How about training to get a promotion? Earning more will help you sock away more, and making yourself more valuable to your employer (if you’re an employee) will reduce the chance that you’ll lose your job in the first place! And starting another income source up will reduce your dependence on your main job.
Basically, get “scared” now so that you’ll be in a better position if something bad happens. Charging it only goes so far.
