Let’s pretend you’re a moron who improperly shovelled the driveway, leading you to fall one Thursday night (at 6 pm) and break four bones in your ankle and leg. Suddenly you’re unable to get to work, have meds and crutches to buy, and several comely masseuses to employ. How do you finance this?
Or maybe you’re like Mike the newlywed.
“We’re enjoying the gains from our mutual fund portfolio but we’re also nervous about having 2/3 of our savings invested. What is your advice for keeping a rainy day fund and how much to keep invested in the markets?”
If you follow the advice of the Jar Lady, or all the banks, you might think you need a stash of cash equal to three or six months’ worth of normal expenses. In fact, when baby financial advisors are trained, that’s exactly what they’re told – clients should always have a savings account full of accessible funds. Sadly, now that the TFSA is a reality, that’s what 80% of the people with them are doing. And what a waste.
Banks, by the way, love emergency funds. For example, here’s what the Royal instructs you to do:
“Having an emergency fund means having one less thing to worry about when the unexpected happens. If you find yourself in a situation like a medical emergency, an out-of-the-blue home repair, or losing a job, you don’t want to be worrying about how you’re going to manage expenses or going into debt to cover costs. An emergency fund will let you focus on getting your life back to normal.
“But how much should your emergency fund be?
Most financial experts suggest you have at least three months’ salary in your emergency fund. How much is that for you?”
For the bank, this works. They get thousands of your dollars which it can lend out to some schmuck so he can buy a Kia at 8% interest with a loan that lasts longer than the car, while they pay you 1.1% (the fancy ‘high-interest’ account). No wonder they like emergency funds. But for you, it’s a ridiculous idea.
I don’t know why most advisors don’t get this. Google ‘emergency funds;’ and you’ll end up with endless rubbish like this:
Calculate your monthly expenses.
Make a list of all of your regular monthly expenses–housing costs, food, utilities, debt repayments, transportation costs, insurance and all of your other “must-pay” bills. Then, total your monthly expenses, and multiply the resulting figure by the number of months.
Open an account.
Since you want your emergency fund to remain fairly accessible, a savings account, money market account or short-term certificates of deposit make good sense. Any one of these accounts will give you the liquidity that you need, while still earning you some interest.
Determine how much you can afford to save.
If you’re like most people, it’s going to take time to build up your emergency fund–probably even a lot of time. Look over your finances, and determine how much you can afford to put towards your emergency fund each month.
Set up automatic deposits.
Make saving easy by scheduling automatic deposits to your emergency fund. Then, sit back and watch as the balance grows month-after-month.
Okay, so why is saving money for an emergency a bad idea? How is this tried-and-true advice so flawed? Why do I believe any advisor telling you this should be covered with Saskatoon berry compote and fed to fire ants?
First, we’re in a low-yield world and will be for some time. Money in a savings account is dead money, barely able to keep up with inflation and certainly not growing your wealth. Second, the greatest risk we all face today is not being able to cope with an emergency, or losing money in a bad investment, but running out of income. Given the fact most people have saved or invested peanuts, you certainly should not be sitting on thousands of dollars doing nothing.
Fourth, almost all intelligent investments (which excludes the worst of the worst, such as locked-in GICs) are liquid, and can be turned into cash in a few days. If you have an investment advisor and an actively-managed account, there will be cash there that can be immediately deposited into your bank account.
Fifth, most importantly, this is why God made lines of credit. You can go to the bank, arrange for a LOC for $10,0000 or $50,000 or whatever they’ll give you at reasonable rates. If you have a good credit rating and a house, an unsecured line should come at 3.5% or 4%. If you’re homeless and go to the bank wearing a garbage bag and unmatched flip-flops, expect to pay a bit more.
The point is a LOC costs nothing to set up and zero dollars to maintain. If you never draw upon it, you never have debt. But if an emergency befalls, all you need do it dash off a cheque. In the meantime all that money the Jar Lady would have you sitting in a plastic bag in the tank of the guest bathroom toilet can be invested in growth assets within your TFSA.
Now, go salt the damn driveway.