Recently, Financial Finesse was fortunate enough to hire Steve White – a bright and handsome gentleman from Texas. If you doubt the handsome part, just ask him…he’ll tell you! Steve shared his view with me of why an emergency fund is critical for your life, and it sounded like something I should share with you.
“Interests rates are practically at 0.0%. Why do people keep telling me that I need to I need to keep 3 to 6 months of expenses in a savings account? That is over $12,000.
By the way, how can I possibly need $12,000 in emergency expenses when my wife and I have stable jobs? We need every dollar of the $4,000 we take home. We could simply put any expenses on our credit cards and pay it off over time.”
A friend said this to me during halftime at our kids’ basketball game. Financial advisors have said for decades that you should keep 3 to 6 months of expenses in a liquid cash reserve for emergencies. Back in the day (pre 2008), you actually earned some interest on those assets…not much but a couple hundred dollars. So why not invest those funds and rely on credit cards for emergency expenses? Let’s see what Murphy’s law can do to put this in perspective:
Health Insurance Deductibles: Many of us have what are known as high-deductible health care plans. They have high deductibles of typically $2,500 to $5,000. So if my son, the little Steph-Curry-want-to-be, needs an emergency appendectomy, my high deductible will be reached. That means $5,000 will come out of my pocket.
Car Insurance Deductibles: We have 3 cars and 4 drivers and our auto policies have a $500 deductible. It is fairly easy to do $500 of damage to a car so add in $500 for the bumper we dinged in the E.R. parking lot.
Homeowners Insurance Deductibles: In Texas, we get hail storms and they can do damage to roofs. My homeowners policy has a $500 deductable for all claims except hail. Hail has a $6,000 deductible. (I don’t like hail.) So a claim is going to cost me at least $500 or $6,o00 if it’s a hail storm.
So if Murphy’s Law visits us and we have an emergency appendectomy, a fender bender and a hail storm, our out-of-pocket costs will be $12,000. This doesn’t include any of the other expenses that may occur. Let’s look at what happens if we put that on a credit card:
With a $12,000 balance at 15% interest, the card is paid off in 2 years with payments of $582 a month. That $582 is almost 15% of my friend’s $4,000 monthly income. This means he would have to find $582 that his family is spending now and cut it out of their budget. He will also pay $1,964 in interest. If he can cut $582 out of his budget then, why not cut a portion of that now, build an emergency fund and eventually invest the surplus?
Why not invest that $12,000 for a higher return? Investments carry market risk, which means they can go up and down. The S&P 500 is down almost 10% year to date for 2016 (as of this writing), so $12,000 would now be worth $10,800.
Can you sell it and pay most of the deductibles? Of course you can. But most people, me included, don’t think it is worth the risk of having to sell an investment in a down market, especially when all it takes for me to need $12,000 is one appendectomy, one car accident and one hail storm. The lesson for all of us here is to pray for health and good weather, but keep a solid cash reserve just in case!