Elizabeth Kerr talks emergency funds, and why your credit cards and mortgages don’t count

Elizabeth Kerr talks emergency funds, and why your credit cards and mortgages don’t count
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By Elizabeth Kerr

Sometimes things happen that take our lives by surprise and leave us completely dumbfounded and exhausted.

A sudden passing of a loved one, getting fired, the love of your life decides they need to “find themselves”, or a “car just pulled out from nowhere”.

Regardless of what it is, you are left holding the proverbial can, and need to figure out how to get back to the new normal as quickly as possible.

For some "life-lemons", having insurance will be a God-send. But insurances don’t cover surprise babies, wayward lovers or losing your keys - and they usually have a stand-down period whereby you have to support yourself until the money is paid out.

For that time and every other life disaster you need an EMERGENCY FUND!

What constitutes a financial emergency?

There are two categories an emergency fits into:

  • An unexpected expense, whereby, for example, something happens and you need to spend money to get through it. Examples of this could be a rescheduled flight to get home in a hurry, or seeing a dentist, or a car needs a new battery. You get the idea.  
  • A loss of income emergency - for example, being fired, taking a pay cut, or having your hours/overtime reduced.

How much do I need?

You need enough money to meet your non-negotiable expenses for three months – shelter, food, insurance, basic transport and one communication device.

Obviously, if you are without income you won't be taking holidays, updating your wardrobe or treating yourself to lunch out every day, so, there is no real point in having any extra money over and above your non-negotiable needs set aside.

Your emergency money can form the base of your money machine.

If you’ve been living payday to payday and consuming on a whim, then putting money aside for no realised reason is probably a challenge.

If you are starting from $0 then your first goal is to get to $2000 - ASAP!!! This needs to be done with the same energy you would employ if your pants were on fire.

We will call this your emergency kick-starter.

The sum of $2000 will cover most short-term emergencies such as accommodation or flight changes, basic car repairs, a few days off work, or paying your rent and the like. The rest of your emergency fund can be made in regular deposits over 3-12 months after the initial $2000 is saved.

Build an emergency fund, or pay off debt?

That is a good question.

The answer is a bit ‘chicken and egg’ and it depends on the types of debts you have. If you lose your job, your debts are still going to need to be paid. You will need to have enough money set aside to sustain these debts as well.   However, if you pay your debts off then you won't need as much emergency money.

My suggestion is that if you have consumer debt such as credit cards, personal loans, payday loans, overdrafts, or store loans, then save your $2000 ‘Kick-Starter Emergency Fund’ first and then focus on ploughing through these debts – starting with the highest interest rate bearing one first.

This involves lining all the debts up from highest interest rate to smallest. Then make the minimum repayments on all of them - and on the highest rated one put every single cent you can spare toward it until it is gone, before moving to the next and so on and so on.

In the meantime don’t do anything that might put your job at risk or cause you to take on more debt.

Once you have worked through all of these debts and paid them off, you can then focus back on building up the rest of your emergency fund to cover three months of your non-negotiable needs.

But, my credit cards/revolving mortgage/vintage motorbike/stamp collection are my Emergency Fund

“Uh-uh! No they’re not”!!!

During the Global Financial Crisis, specifically in America, those people who relied on their credit cards or revolving mortgages for their emergency fund suddenly found themselves broke and with no way of paying for their basic needs.

What happened was that banks needed to carry less risk and began closing down people’s line of credit with no warning.

Come pay day people would dutifully pay down their credit cards then...BAM!...money is swallowed up and credit limit reduced to the remaining balance, giving them no wiggle room to pay for anything.

The same would happen to their revolving mortgages.

If the bank felt they were carrying too much risk on a particular property then they would just swallow up the persons salaries as they were paid into their revolving credit accounts and reduce the limits – essentially leaving them with nothing. This didn’t happen here in NZ but there is no saying it can’t, and so that’s why I think it is best you keep your emergency money in cash in a separate banking institution from your mortgage.

That new TV is not an emergency

Too many people save well and deposit money into their emergency fund only to pull it out again prematurely for stupid things that do not constitute an emergency.

Replacing your TV is not an emergency, taking advantage of “once a year sale” at Briscoes is not an emergency, buying a second car or taking a supposedly well earned trip to see an 11th-cousin's wedding does not count either.

If you don’t have money to buy these things aside from your emergency fund then you can’t afford them yet.

Ways to build your Emergency fund?

Obviously the first thing that springs to mind is to save money from your pay each month. But raising money doesn’t have to just come from your income. You could try any of the following:

  • Sell stuff on Trade Me. Old clothes, books, bad Xmas presents, or projects you know you will never get around to completing.
  • Take on some extra work for a few months, such as babysitting, ironing, gardening, stacking wood - whatever you think you are capable of doing. You don’t have to do it forever – just long enough to get your fund full.
  • You could take advantage of last week's column and give away the sky TV subscription and the gym membership and save that money instead.
  • Review your insurances - there may be some savings in premiums, which you can bank instead.
  • Review your mortgage. With rates coming down, chances are you could break and re-fix your mortgage and save yourself some money in interest payments. (Watch for break-fees though).
  • Ask for a pay-rise at work. Or work extra shifts until you have saved enough.
  • Just stop buying stuff! If you have food in your belly and a place to sleep then everything else is a bonus and you don’t need to buy it until you have your emergency stash sorted.

One other thing...

You need your emergency fund to be converted to cash quickly, otherwise it’s likely next to useless.

Kids' bank accounts don’t count either.

Either you’re putting money away for your kids or you are not. (Personally we don’t do this and I’ll cover off why in another column one day). It is not your kids’ emergency – it is yours and it just doesn’t seem right to me to take from these accounts. If you need to, you should stop contributing to kids' accounts until your fund is full, and then go back to saving for them if this is an important financial goal for you.

Concluding this week...

Having an emergency fund limits the drag on your future self by being able to cope when life throws you a curve ball. My hope for you is that you will only have to save for this fund once and that ‘touch wood’ you will never have to use it.

For those who are in a relationship, having an emergency fund will positively affect the way you relate to each other – you just have to trust me on this!!!

For those of you not in a relationship – having an emergency fund makes you damn sexy!!! It says you are smart, you have security, you can set a goal and you can prioritise.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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The next question is where to put this money? A term deposit used to be my choice. But with the Oz owned banks now having a 30 day notice period for early withdrawl, I would suggest opening a Kiwiwbank account. At Kiwibank I believe that they still have complete discretion to be able to authorise a break in a term deposit immediately upon request. (Without going through hoops). Sure, it may be denied if there ia another GFC freeze, but in that situation it affects everyone, so there may be some legitimate leeway in paying bills.
I suggest that a savings account is a bit too tempting.... Best to have some sort of cut in interest as an incentive to leave it untouched.

I go with a tiered system.  Savings account as the first tier, and when it hits $5000-ish, I peel a couple of thou off and roll it into the long-term investment pool.  Leaves enough in the slush fund to cover most emergencies I'm likely to have, and the rest is accessible within a few days, or at most weeks, but it's enough of an arse-ache that it isn't a temptation to dip in.  Some of my term deposits are with a credit union that lets you make partial withdrawals, so for an extra-expensive emergency, there's that option.
Also have a bonus bond account just for fun and designated as the major appliances and furniture fund  - the things where you can have a good idea of how far in the future you'll want to replace, and adjust contributions accordingly.  I stick an impulse $25 or so in whenever I think of it, and don't let it mount up too much beyond what's reasonable for a new bed, computer or fridge. 

 I thought staggered term deposits: 12 individual months of X amount so if the sh*t hit the fan - there would be a monthly income for that period of time.   I think 3 months would be the absolutely minimum. Where to stick the money??

Emergency fund should be in an online call account. It'll earn sweet nothing in interest, but it's available on call.
Speaking of emergency funds, I had to pay $650 for new brakes yesterday. Wiped out the money I'd made on recent trademe sales - but that's the joy of car ownership

Just the pads or discs as well?  Learning to fix a car can save you thousands over a lifetime, even passively by simply using your knowledge to avoid being ripped off. 
I use rabo banks savings account because it makes it hard to get my hands on (have to use a remote hand peice to log in and funds clear overnight so takes out any impulse buying) and is easy to forget about (and I contribute to it weekly so grows without me knowing). Over 4% rate for the account I use which only gives this rate if you contribute $20+ a week to it, otherwise rate drops to 1%. 
And the biggest reason people dont have emergency funds is because they have learnt over time that they have a safety net in the form of parents or partner that will bail them out, neither a real long term solution

Ouch, I assume that is new disks? original manufacturer?
Typically my disks are $35 each, brake fluid $10 and $80 for a pad set and < 2hours work incl bleeding per end.

Heres the blurb I found on stuff.  If anyone's got a better way please share!
 Let's say you want to set aside $8000, and that your bank offers 3-month, 4-month, 5-month and 6-month term deposits – as most banks do.
Start by putting a quarter of your money – $2000 in this case – into a 3-month term deposit, $2000 into a 4-month deposit, $2000 into a 5-month deposit and $2000 into a 6-month deposit


Then, as each deposit matures, reinvest it in a 4-month deposit.
Your first $2000 will therefore be available to you after three months, then seven months, then 11 months and so on. Your second $2000 will be available after four months, then eight months, then 12 months and so on. For the third, it will be five, nine and 13 months. And for the fourth it will be six, 10 and 14 months – and on into the next year.
In other words, at any time you will have $2000 maturing in one to 31 days, and another $2000 in 32 to 62 days. You can then put expenses on your credit card, knowing the term deposits will be maturing to cover the bill.
Laddering enables you to receive what are usually higher interest rates for longer-term deposits, but also to have money available quickly when needed.   

Although the 4 monthy rate is fairly low.
What's the break fee on a 5yr one? If its not too high, it might be simpler just to stick it all into a 5yr one.

Clever but term deposits are so hard to justify on small amounts.
E.g. looking at Rabodirect, they don't do 4 mnths but do do 3 mnths current rate 3.55%. That is vs their call account rate of 3.25%.
So the difference on $8000 fully invested in the 3 month deposits vs all in a single call account works out to be $24 p.a. in absolute terms, before any consideration of tax which will lessen the difference further.
Hardly seems worth the time spent mucking around and the maturing delays does it.

The trouble with term deposits of under 5k is that you get next to nothing bavk.
A quick check of BNZ rates showed 2% was all you were going to get.
Heartland Bank have term deposits with a minimum  of 1k and a lot better interest rate.

Just use a bonus saver account. Rates are as good as 6 month deposits (around 4.3%). These have the incentive not to touch them but money can be available when you need it.You will need to setup a recurring payment for the minimum amount each month (normally $50-100) to qualify for the bonus. This way, you also force yourself to build up some savings over time.

Cutting expenses is the best way to ensure long-term safety. We have designed a life where all of our key expenses can be covered by one income so if either of us loses a job then it just means that we are not saving any extra during that period.
Our money machine built from the money invested is growing quickly and there will come a point in a few years where that can cover all of our expenses i.e. the income it produces could pay the bills rather than be re-invested. Life inurance is used temporarily to provide the extra capital needed should the worst case happen. This insurance gets reduced as our money machine grows and will be retired once financial independence arrives.
We also have liquid investments that can be accessed if required. So, in theory, we never need any cash on hand. However, in practice this lifestyle always generates a float of cash waiting for a good investment opportunity over and above our regular investments.
In summary, low expenses and good investments mean there is no such thing as an emergency.

Agreed entirely.
I'm the sole earner in my household of 3, and we base our budget entirely on my (meagre) salary. We topped up our mortgage taking advantage of the low interest rate to invest in stock index futures, so despite exposure to equities the actual portfolio is entirely cash (margin) - meaning equity-type returns and basically overnight liquidity.
This pay-down-your-debt "Money Machine" education piece is fine as a long term general guideline but people when doing financial planning and asset allocation need to be aware of the current economic environment, what phase of an economic cycle we are in. With interest rate at historical lows, cash overflowing with nowhere to go, and central banks providing an effective back-stop and artificially pushing down yields, I would think it sub optimal to be conservative with your balance sheet. Leverage should be your friend as long as the borrowing is used to finance investment, not consumption.
That said as the recovery ages in future, it'll be necessary to adjust your allocation to a more balanced/conventional state. The idea is allocation should not be statis but reactive to the economic environment and the stage of life you are in.

Looks like you can afford to take the risk but I wouldn't recommend leveraged futures to anyone who does not have lots of spare cashflow. And the taxman might look upon you as a trader and subject you to capital gains.
I prefer long-term investment in undervalued markets - just buy and hold the indexes. They are liquid enough to be sold in one click should the need arise.

You are right - we are a young family, so low salary, no savings yet, hence borrow to invest, can afford risk-taking given long horizon, etc.
Though futures does not necessarily mean leveraged, you can build a however much buffer on top of the minimum margin requirements, so it can be just like an ETF, but with arguably better liquidity for index futures at least (in scenarios of 2008 perhaps). Another advantage is you can tone up/down leverage easily, easier than with an ETF?
Anyway my point is you should have a balanced portfolio for your age & circumstances, etc, but also the mentality that flexibility should be part of it, that portfolio risk profile should not be static but adjust to the economic cyclicality. e.g. the same 10% allocation to term deposits may be too low in 2007 with skyhigh interest rate and the economy overheating, but doesn't make a lot of sense in an era of negative rates and the economy in recovery.
The education piece is focused on the 1st part I guess.

If you are borrowing to invest then you are leveraged. If you make a loss, you still have to pay interest on the borrowed money which is now worth less than you borrowed.

This is pretty silly....borrowing to invest? Low salary, no savings?
You'd be much better off putting a nice percentage of your wage into a super scheme and choose an aggressive (growth) fund to invest in.
You'll end up investing in most of the things you'd be investing in with your borrowings, but you'd have no loan to pay back at the end of it, and the long term horizon means you have plenty of time to sit back and see your nest egg grow.

Now this is pretty silly - borrowing vast sums of money relative to your income to invest for gains on an already overpriced,  undiversified cashflow-negative assets. They call these people property investors and apparently they are the smartest people on the planet.

Yes, pretty silly, I agree.
They don't fit my definition of 'smart'.
Greedy, maybe, selfish, definitely.

"Sily" is a bit over.
You can put a slice of your wages every week into your nest egg or you can monetise by borrowing a lump sum against those slices - just like you can save for 20 yrs and buy a house or you can borrow a lump sum to buy now. Basically just plain old leverage, or not. People seem a lot more comfortable to borrow to consume (when you'll never see the money again) than invest, on the comforting self-assurance of necessity, as in credit cards or owner-occupied house.
Say I'm on a half million dollar mortgage for the house (typical these days, right?), what's another 50k on top of that, remember at 5% p.a. - if the original mortgage is, say $600 weekly, another 50k would add another $60 in repayment. Not a material difference now, let alone if you have 30, 40 yrs of career progression in front of you. If you are long-term investor and can endure the fluctuations in your investment value, you are earning the spread between the stock market returns and the historical low mortgage rate, which is positive over long term (not to mention NOW, with QE, etc). Otherwise it'll take years (8 to be exact, if assume 15% return on your aggressive scheme) to accumulate 50k in savings, and $60 a week gets leaked easily here and there.

Um, "During the Global Financial Crisis" and where is that $2k kept safe? in a bank deposit? oh, um OBR event?

An OBR event is designed to keep the banks working so people can pay the bills. Looking at where bail-ins have been used previoulsy, only money over a certain amount was frozen so it's likely that your $2000 would be safe.

For the OBR the checking/chequeing account differs to the deposit account? at least this was my understanding.  On top of that Ive seen nothing suggesting a) it would be safe and b) a portion at least would not be frozen, if not all of it.   You could be making an un-safe assumption.