Yesterday, I discussed a post over on Enemy of Debt that I didn’t completely agree with. But that’s not the end of the disagreement. (I should add that Brad and I chat amicably most of the time. He’s a totally good guy; he just has the bad taste to not have my exact views. Silly man!)
Brad and I got off on the tangent of emergency funds. He was concerned that we don’t have any savings in case of emergency. I explained my point of view: Emergency funds may not be the best use of your money.
That’s how a long, long discussion began in his otherwise normal comments section.
Our system
Once a week, I leave a certain amount in the bank. The rest of the funds are put against our credit card debt.
Pretty simplistic, I know; but it works for us. If an expense pops out of the woodwork, we try to cover it with our weekly funds. If that isn’t possible, we put it on the card. One to two weeks later, it’s paid off.
After our credit card debt is paid off, I will make an emergency fund one of my top priorities. Until then, though, it just doesn’t make good financial sense for us to put away money that could go toward debt. My disability checks will always cover rent. If Tim and I both found ourselves out of work, we have the option of applying for food stamps until we could get back into the working world.
Brad’s concern
Brad accepted that perhaps it was a tenable system for smaller amounts. He asked what would happen if we couldn’t pay the whole amount off in a single month. Then, we’d be back to earning interest on the card.
First of all, the expense would have to be pretty significant. About $2,000, to be exact. Since we pay between $1,500 and $1,800 a month, we could get rid of any lingering balances pretty quickly. Of course, sometimes big, expensive emergencies crop up.
So my other answer would be this: We’re still better off.
Let’s say we have to charge $2,500 or so onto the cards. We couldn’t pay that back in under a month. So it would remain on the card and accrue some interest.
Even so, we’re still paying less in the long run. If you’ve kept $3,000 back from debt reduction, that’s $3,000 that is accruing interest all of the months it sits there. So even a couple of months’ interest is less than the interest you paid when you decided not to apply your emergency funds to your debt.
The trouble with EFs
In a way, you’re paying a premium for the privilege of an emergency fund. Let’s assume an average APR of 10-15 percent on a credit card. Banks are offering perhaps 1-2 percent. That means you’re paying around 8-13 percent in interest on that money in the bank.
In addition, EFs manage to take money away twice. First, you put the money into an account, rather than using it to pay down debt. Later, as you use the money in the account, you have to put more in to replenish your fund.
That’s twice that you have to divert money from a productive, current need into a “what if” account.
So what’s it to you?
Obviously, I’m not in the majority here — either in opinion or financial situation. Still, I think it’s safe to say that not everyone benefits from getting an emergency fund.
My main contention with the whole concept is that there are some logical fallacies inherent in them.
Dave Ramsey
Dave Ramsey tells you to save up just $1,000 then get on with debt reduction. In a pinch, this would pay your rent for one to two months, max. In that way it’s useful, but I think most of us associate “emergency fund” with some huge, unexpected bill.
If the emergency is more than $1,000, it sort of seems like the whole process was kind of pointless. A $2,000 car repair bill will mean you’re still adding to your card’s balance. You can charge a smaller amount, but the results are about the same. You’ll pay off the $1,000 you charged, and you’ll need to replenish the EF with another $1,000.
How is that so different from charging the whole $2,000 and paying it off with your next couple of checks? Either way, you’re paying $2,000. Of course, if you have an emergency fund you do get to let $1,000 sit around, essentially gathering dust, while your credit card debt gathers interest.
Traditional EF
The more traditional suggestion is to have 3-6 months’ expenses in the bank. That’s a goal to shoot for even while you’re still paying down your debt.
On the face of it, at least this concept makes a little more sense. You save enough so that you could pay a few months’ expenses in case of lost income. It seems like there’s more point to that than the arbitrary $1,000. Once again, though, there’s the problem of how to best use your money.
If you could live on $1,000 a month, then you would need a minimum of $3,000 in the bank. Meanwhile, the alleged average credit card debt is around $10,000. So your emergency fund would be about a third of your overall debt burden.
Following the plan’s rules, then, you have enough to pay off almost a third of your debt; but instead you don’t touch it. You’re told you might need it later.
But don’t you also need it now?
Suze Orman
Suze Orman’s new suggestion is to build up your savings at any cost. Keep up with minimum monthly payments, but otherwise funnel your money into savings.
It’s a credit card company’s dream come true: You’re making timely payments, and the company is making interest revenue hand over fist. I hope it’s clear that I find this whole idea to be pretty problematic.
Back to the drawing board
Please don’t get me wrong: Depending on your situation, you may need to follow one of the philosophies that I disagree with. I’m completely okay with that.
Finance is as much about psychology as it is about math. While I find comfort in not letting funds sit around idly, others need to know there’s a safety net, just in case. Whatever lets you sleep at night.
I’m well aware that you can’t really dictate what works for everyone. That’s usually my point when I talk about stuff like this: There are exceptions to the rule — more often than you might think.
Which is why it’s amusing to watch people’s reactions. Inevitably, someone will argue with me, implying that my method is imprudent or financially harmful. I then explain the math and/or logic behind my system. The argument ends after that. Yet, almost inevitably, the person tells me that personal finance is personal. So what works for me might not work for everyone else.
Um…
Getting back on point, I just want people to realize it’s okay to ask questions. Even when it’s one of the most basic rules of personal finance, it may not be for you.
Our individual situations are, well… individual. You need to figure out what systems work best for your purposes and goals. Choose what makes the most sense for you, what best meets your needs and priorities.
Whatever you do, just ask yourself this from time to time: Am I doing this because it’s right for me? Or because other people told me it was right?
What’s your take on emergency funds? Do you ever have to alter (or discard) basic tenets of personal finance?
I would argue that you do have an emergency fund. Your emergency fund is what left in your savings account on a weekly basis. It also sounds like your emergency fund in the ballpark or greater than the Dave Ramsey emergency fund on a monthly basis.
I think that most personal finance websites acknowledge that there are different ways to tackle debt. They may not on an individual post, but if you read on a consistent basis, they will describe the various philiosophies and whether they agree and/or follow.
Interestingly enough, my husband made the same argument about our having an emergency fund. I disagree with that definition, though. What I keep out of our checks is enough for the weekly expenses. Emergency funds are supposed to be distinct accounts which are accessed only for large, unexpected costs.
Also, generally, I would agree that many PF sites are open to different ways to tackle debt. But whenever I mention our not having an EF, I'm invariably told that I'm being financially myopic and/or leaving myself open to disaster.
My understanding is that Dave Ramsey recommends a $1000 emergency fund when eliminating debt. If you are paying down ~$1500 a month in debt than you must keep ~$300-$400 in your account every week. If you pay your credit card bills once per month, than your 'emergency fund' could be anywhere from $300 to $1500 depending on where you are in the month.
Thanks for clearing up the confusion! The misunderstanding there arose because I actually pay weekly, since my husband's unemployment checks come that often.
I actually wrote a post about how nice it is to pay so often and see some quick results. When my husband gets a job again, I'm going to try and stagger my contract work invoicing so that I get paid the weeks he doesn't. It's a system that really works for us.
We had a bunch of disasters which basically killed our savings and cost us a butt load of money. So now, because we finally have an emergency fund, which I need for my piece of mind. Hopefully at some point we will have our debt paid off, and I think we are close to the amount that we need to feel "okay" at night. I don't think I would plan for both of us to lose our jobs (that sounds unlikely) but I want enough so we can replace the crap car my husband drives without having another bill coming in the mail.
It sounds like a good plan for your needs. I think there are plenty of people who prefer to have some money in the bank to help them not worry. I'm glad you've found a system that works for you.
One of the first things I plan on doing once our credit cards are paid off (besides starting an emergency fund) is to start a car fund. For now, one car suits our needs. But if it dies (it's nine years old right now, so I think it has some life in yet still) it would be GREAT to be able to pay outright. If nothing else, it gives you such a great leverage position!
When we were knee deep in "alligators" we threw every penny at debt. We still have debt but it is much more manageable and we now have a savings account. We did have a savings account before illness struck and it ate all those funds and more. Bottom line, I do agree with you that everybody just needs to do what works for them. When Tough stuff happens I am not sure we could have had "enough" in savings.
True, there is the argument that there's never enough to feel safe. I think it's mostly about the illusion of safety — which is what helps people sleep at night. And I'm not denigrating that. If we succumbed to the reality of the situation, we'd all be completely non-functional because, as you well know, things can turn at the drop of a hat. Suddenly, everything is different. Since we can't control every outcome (despite my valiant attempts for us) it's best to figure out what makes you feel best and, preferably, gives you some semblance of reassurance.
Personal finance advice varies so much that by following one person's rule, you're breaking another expert's tenets.
Mathematically, I think your method makes sense. Putting $1500 per month toward debt is amazing – and I don't think there are too many emergencies that will befall you that are more than that. By not putting that money into a savings account, you're earning that credit card APR "back" every month. (I'm not sure if I'm explaining it correctly, but it makes perfect sense in my head.)
I think the biggest problem some people have had recently is that, as they're paying down their debt the cc company is lowering their available credit. So, if you had $5,000 debt and a $1,000 EF & you had a $700 car emergency you could pay for it with your EF. If you put that $1,000 towards debt you'd only owe $4,000 and expect to be able to charge the $700. All well and good, unless the cc company has lowered your limit to $4,000 without telling you!
This is an excellent point! Thanks for reminding me of this. Only one of our cards has lowered our limit. Probably because we're not using it enough? I don' t know.
(Whoa, there's a *limit* on comment length now! Part2 of my comment)
Something like that actually happened to us with our Home Depot card. We had $2,500 of credit and kept doing renos on 0% 6 or 12 month payment plans. We paid off 2 plans in a short period of time and went to buy a shed. Surprise! Our limit had been lowered to $600 (we still had one payment plan of about $500, so less than $100 available). Luckily a few minutes on the phone straightened the matter out and raised our limit to $1,600 but a) that's not always the outcome and b) you'll notice that $1,600 is not the same as $2,500! We've paid off that $1,500 now and are looking at our next reno. I checked last week, just to make sure that they hadn't dropped the limit again!
For a long time I was trying to pay each credit card with twice the minimum payment. Only we didn't have enough money to do that so we kept yo-yoing up and down each month. Now I am paying extra on each card, but not twice the minimum. I took advantage of my employer savings plan – no matching or anything – but basically the money comes from my check and goes directly to a savings at a credit union. So I am effectively building an emergency fund with that money. We are close to $700. I totally get not having an emergency fund but pay off the debt instead, but I realized that it helps my peace of mind to know that we have some money socked away for the inevitable car repairs, since we have three vehicles older than 10 years. Quite a discussion you and Brad have had, very respectful and intelligent on both sides. Kudos.
I think that you should keep at least $1000. What happens if you are laid off for a few months, say six, paying off the credit card debt in such a quick manner might be a bit difficult, though maybe not depending on severance/unemployment benefits.
You're system works well for you, and that's awesome. But if catastrophe stuck, medical, something else major, I'd say you are much more susceptible to a larger hit down the road via CC interest.
MFO,
I am on Medicare, so medical disaster is pretty much covered, though the deductible may hurt. If Tim were to get sick, that's where the danger lies and, unfortunately, hospital charity is set up in such a way that $1,000 in the bank would actually hurt us rather than help. As it is, we'd get set back by a percentage of whatever the cost was, but by having assets in the bank, it would actually make it more likely that we'd get less help in the end. It sucks, but such is bureaucracy in motion.
As for being laid off, Tim is already on unemployment. My contract work is up for renewal at the end of June. For now, we're assuming it won't be renewed, though, hence the big push to pay off by the end of that month.
The next order of business is to find Tim some catastrophic insurance, lest something happen. And once debt is paid off, we'll start chunking down an emergency fund and, if he still hasn't found work to get him insured, we'll need to find some self-employment insurance or something similar. (Regular plans won't take him because he had MRSA more than twice in the past three years.)
We're saving right now, but since we're not married our accounts are separate and we have one joint savings account. He is about $3-4K in debt and I have none, and we add a tiny amount each month to our house/emergency fund. Whichever comes first, I guess. I think your plan sounds like it works well for you & you should stick with it. People need to figure out how to manage their own finances, regardless of what experts say or the common thought its.
The main problem that I see with your method is that it gives you a false sense of paying off the card. I recall a post where your credit card was down a bit but you actually stated that you had paid quite a bit more because you had charged all this other stuff on it and paid it off. That other stuff shouldn't count as paying on the card–it should just count as daily living expenses because that's what it is. Charging a trip for a planned bachelor party and then paying it off isn't paying off your credit card–it's just staying in the same place.
Your credit card debt is going down very slowly and I think that you have a false sense of how much you're paying it down because you keep on charging it back up. I don't see you getting and staying out of credit card debt because of your willingness to charge on the credit cards even though you have a history of not being able to handle them, hence, your credit card debt.
I'm sorry, I realize that this post is a bit harsh but I'm not in credit card debt and have never had a problem with it.
I don't think you're being harsh, simply stating your point. And I will definitely take that one into account in re: considering how much debt is being paid off.
That said, we're not in credit card debt because we didn't get into debt from frivolous spending. Tim brought defaulted student loans to the relationship. At that point, I couldn't work and his work was spotty due to health problems, which added a lot more debt over time. (For example, the $8,000 we had to spend to get his teeth dealt with. That wasn't a choice: he was down to semi-solid food and in constant pain.) Plus all the doctor visits. Last year, we spent something like $10,000 on medical bills — about 1/3 of our income. In other words, 50% of our pre-tax income went to rent and medical bills.
So I feel confident that we can and will get/stay out of credit card debt. As soon as the cards are paid off, I will be chunking at least $500 a month into an Emergency Fund so that we can avoid a running balance on the cards.
Point taken. I didn't realize that most of your credit card debt was from medical expenses. I hope that you are able to get Tim some sort of health insurance so that this doesn't happen again in the future.
Again, sorry, I didn't mean to be harsh
Three problems I see with not having an emergency fund:
1. Counting on credit being there. Yes, credit has been easy to obtain for most of our lives, but that might not always be the case. In fact, credit has been much harder to obtain throughout the recession, hence why people couldn't just keep borrowing. Many of us have had our limits lowered even while making above-minimum payments on time. If my husband and I had needed credit we would have been out of luck. We paid down one card and they lowered our limit to the new balance. We paid off another and they cancelled it. This is despite having a good income and stellar payment history. If they'll do that to us, how about someone in an actual emergency? Even if they did give you credit, it may be at much higher rates because they know they have you cornered.
2. Counting on income being there, including safety nets. You count on your disability payment, but the government isn't perfect. It screws up sometimes and money doesn't get where it needs to go in a timely manner. It takes time to get on food stamps. It takes time to get unemployment. I had a friend lose her job and it took her MONTHS to get the unemployment she was owed. The bills didn't stop coming, though.
3. Unexpected withdrawals. Unexpected expenses are one thing and you can put them on a credit card, however unexpected withdrawals are a good reason to keep money around somewhere for use until things get sorted out. For example, we have our mortgage on auto-pay, but one month it withdrew twice in about two days because the mortgage company had calculated the first payment wrong but then instead of refunding us the difference they sent through another bill thinking that the system would just ignore the first one. It didn't. Fortunately, we had enough in our checking as a "buffer"/ mini emergency fund to cover it until things got straightened out (which wasn't immediately as it happened at the end of the week).
So, yeah, I'm a big believer in having an emergency fund if there is any possible way to have one. I definitely sleep better at night having one and what I pay in interest to have one is not only worth it, it isn't so bad considering the what I might end up paying if I didn't have one and needed money quickly.
Having traveled the spectrum from incredibly broke to having an emergency fund, I can see your logic and in my world, you may not have an emergency fund per se, but you have an expenses fund. I took a three pronged approach, holding back *some* money for savings (very minimal), paid down debt, and put anything I could towards current expenses to keep that debt from ballooning or growing. As long as I made progress on all fronts, miniscule though it was, I could keep chugging.
It took me a long time and countless, thankless hours to kill off the debt because my parents weren't upfront with me in the very beginning about how much debt they had and did rack up more, but it's probably for the best. If I hadn't become aware of it in 10Kish chunks, I might have passed out. Oops, that was a digression.
I love having an emergency fund, but in my mind, it's incomplete without an expenses fund. From experience, my family is prone to .. well, anything, so I basically think of every possible thing that could happen in daily life and create a fund for it. And then back *that* up with unspecified cash because I simply don't know if at some point, I'll stop being able to earn income.
I may become less neurotic over time, but I .. doubt it.