“I don't need to save for emergencies. If there's an emergency, I'll use credit.”
I was on Facebook recently and a guy said he'd just paid off his credit cards and wondered if he should focus next on paying off low interest rate debt, like a mortgage, or if he should focus on investing.
Ummm…. aren't we forgetting something here? What about the emergency fund?
Now I know the emergency fund is boring. It's money you can't spend (boo) and it's not making you a lot of money (boo). I get it. This is one of my personal weak areas as well.
But you need access to liquid cash savings for a few reasons.
1. In a downturn, banks will reduce risk by reducing access to credit. This is already starting. A card we rarely use contacted us saying they were going to close the account if we didn't use the card soon. A friend who does the points thing with credit cards just had a bunch of cards shut down by the issuing bank because he “wasn't using them the way they were meant to be used.” They didn't mind one bit when the economy was good, but now, they are reducing their exposure.
In a downturn, banks usually fail. At least a few of them. If your bank fails, your checking and savings balances are backed by the FDIC. However, your access to credit is not. In the Great Recession the bank we used for our IT consulting company failed and the bank that took over “chose not to reopen” our business credit cards AND they shut down the line of credit we had with them to provide us with float. And by the way, when things like this happens, the bank wants to get paid back right away. Do you want to be scurrying around trying to get more credit so you can pay off that credit? Isn't it nicer not to have the debt AND to have some extra cash?
I haven't paid much attention to this, but I'm pretty sure the issuing banks have already started reducing the credit lines we have available to us on some of our cards. Check your statements and see if they've done the same to you.
2. If you use credit as your emergency fund, you will come out of the downturn with debt. Which means your first order of business will be paying off debt. Which means you are going to be right where you are now again in 10 years. The only way to get out of this cycle is not to run up debt.
3. Debt comes with payments that are not optional. If I have to use half of my emergency fund, I should immediately start paying myself back, but if I can't, it can wait. With debt, I should immediately start paying the bank yet, and they aren't going to be flexible about that. You are committing your cash flow to someone else at a time when you need it most.
4. If you borrow from yourself in an emergency, it's going to be a 0% loan. If you borrow from the bank, it's going to be higher than that.
You will never win with money if compound interest is working AGAINST you. You need to get in a position where compound interest is working for you.
5. There will be opportunities that come out of a downturn that are only available if you have cash. In the Great Recession our second mortgage lender was willing to forgive a portion of the principal of the loan if we paid it off. We were able to do that with CASH.
In a downturn those who don't have cash look to generate it buy selling things (usually toys first). If you have your financial house in order and also have extra cash, you can buy those things while they are on sale.
As always, you are free to make your own choices, but I've been through several of these cycles now and can tell you, we weren't able to really build wealth until we stopped focusing on building debts.
Are you ready to take control of your personal finances? Would you like some help? If so, schedule a call with me to learn more.
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