Understanding springy debt

[igthebold]

Hi everybody,

Just ready the Springy Debt article: http://www.mrmoneymustache.com/2011/04/22/springy-debt-instead-of-a-cash-cushion/

I don't have any debt besides a mortgage and HELOC. I'm also saving up an e-fund on the side, which leads me to the following thinking-out-loud question for your expert opinions:

I understand it's better to pay down bad interest rates vs investing, since you're guaranteed a 15% (or whatever) "return" vs a 5% (or whatever) non-guaranteed return on investing. Similarly, it's better to pay down debt vs saving for an e-fund for the same reason (15% vs 0%).

So what about saving for an e-fund vs investing? By the above simplistic logic, it's easy.. 5% return vs 0%: skip the e-fund and use a HELOC, like the article says!

Is it really this simple? Am I missing something? There's risk in investment, and the HELOC interest rate is guaranteed, but I'm not guaranteed to need the HELOC anyway.

What are y'all doing?

Jimmy

[arebelspy]

Absolutely it's that easy.

No emergency fund is a slightly more advanced financial move.  I recommend emergency funds for beginners who can't control their spending yet.

An advanced Mustachian with a high savings rate doesn't need one.  For example, the wife and I don't have an emergency fund due to the fact that we can save $5k or so per month.  What emergency will come up that will require more than that?  Something happens (say.. car issue.  Or whatever.) that costs a few thousand.  We just.. don't save any that month, because we pay that bill.  No big deal.

If you save a high percentage of your paycheck, you can just deal with an emergency with your incoming cash flow.  If, on the other hand, you're a beginner who struggles to save $100/month, you should have an emergency fund, IMO.

Beyond that cash flow, we have 80k or so in credit card availability (that we use maybe 1k or so of per month, and pay it off in full).  Plenty to cover any emergency for a short while.   You have a month to pay it off, interest free (regardless of the rate on your card).  In that time you can use any savings from your job, liquidate stocks, sell something, pick up a part time job, whatever you need to pay it off.

But having money sitting around doing nothing is silly.  Unless, of course, it's for taking advantage of an opportunity.  But just to deal with a rare "emergency"?  Pass.

[James]

I agree, it is that simple.
 
We currently have a vehicle fund and some other targeted savings accounts that we are also planning to get rid of as we become savers more in line with arebelspy.  It's really a transitional thing, I think the accounts were benefitial and helpful when starting out, but as I have come to understand mustachian logic it's really a step beyond the Ramsey type stuff into true badassity.  It's not that it isn't for everyone, but it is a more radical departure from mainstream consumerism.  If you aren't going to have the emergency fund and all the programed savings lined up, you better be damn sure you follow up on the living style or you could get yourself in trouble.  But other than that it is a pretty straightforward calculation of where your cahs would come from in an emergency, and if it can be covered without some cash sitting in a low interest account then get those dollars to work!

[Ben]

James,

Another factor is whether your income is predictable or variable. If you 'know' you will be getting a $2,000 check every other week for the next 12 months, your 'emergency' fund can be pretty small (and the higher your savings rate, the smaller the emergency fund needed) since you can count on those paychecks landing in your account.

That being said:
-If you work a more erratic or seasonal schedule (e.g. work on commission, variable hours), you will need more cash in the bank to get you through the 'low periods.'
-If you own a house, you need access to money to pay your mortgage if something happens (liquid, not neccesarily an 'emergency' fund).
-If you own your own business, you will need more cash to stay afloat during seasonal cycles.
-If you are a sole provider, you need a larger 'margin of error' than a dual income household.

But if your salary is predictable, and you make a lot more than you spend, a large emergency fund is an expensive luxury (in terms of opportunity costs) that is slowing down your plans and goals.

[TLV]

Beyond that cash flow, we have 80k or so in credit card availability

Arebelspy, how does one go about getting that much credit? My wife and I only have 5k available, spread over 3 cards.

[Enphuego]

I personally avoid using springy debt as an emergency fund because credit can typically be revoked at any time.  Banks are really good at spotting the types of behavior associated with losing your job and can lower your limit at the worst possible time.  I wouldn't rely on debt for an emergency unless it's guaranteed to be available when you need it.

[AJ]

I'm a big fan of a well diversified emergency fund. I think it is unwise to rely on a single HELOC to be there for you in every potential emergency. Even several lines of credit is putting a lot of faith in banking institutions to be there when you need them. But that doesn't mean you need tens of thousands sitting in a savings account, either.

Its important to be aware of and prepared for the emergencies that you might face. For me, DH and I both have reasonably stable and secure jobs, and could live on a single salary. So, we would have to lose both our jobs before "job loss" would be an emergency for us. That doesn't mean we should be prepared for it, but it will look different to us than to someone relying on a single precarious income. If we both lost our jobs, we could tap our mutual funds. Its not ideal, but its also not very likely. Someone with a single income might keep at least some of their funds in less volatile investments, or CDs.

OTOH, we also live in a flood-prone area. So, we keep $500 cash on hand, in case we need to evacuate in a hurry. That $500 earns nothing, but its more insurance than investment. My mutual funds and rental properties won't help me in a "just need a place to stay and food to eat" kind of emergency.

Credit cards are my "back up" back up plan. They let me keep less in savings than I would otherwise, but I wouldn't rely entirely on them. I don't consider going e-fund-less "advanced", I call it risky. I'd be interested to hear what some older folks think about the issue. It easy for youth to eschew the wisdom of previous generations, but its not always wise.

[arebelspy]

Beyond that cash flow, we have 80k or so in credit card availability

Arebelspy, how does one go about getting that much credit? My wife and I only have 5k available, spread over 3 cards.

Got an Amex in college about 7 years ago.. used it, kept requesting the limit be pushed higher, 5k or so at a time.  Eventually ran that up from 5k limit to 35k or so limit before I stopped bothering (paying it off in full each month, of course).

Then did some free balance transfers (0% interes,t 0% balance transfer fee).  Did one a few years ago, and got new cards for the wife and I, 14k and 12k each.  Then did it again this past year (the offers dried up for a few years in the credit crunch, but have started coming back) for about 10k each.  Could probably close some, but why bother?  It helps more than it hurts.

Then other misc. cards.  We may be close to 90k, I donno (could look it up, but never was interested enough).   Like I said, we only actually charge 1-2k/month (food, utilities, etc), but doesn't hurt to have and start building a better credit score.

Also, I've never had an issue with a bank revoking anything, and all of them at once?  Maybe if the whole economy collapsed, but if that happened I also wouldn't count on the 1k sitting in an emergency fund.  I don't worry about that tiny possibility.

[igthebold]

To Bob's point about unpredictable income, I'm self-employed, but the income is pretty regular, so it's probably easy enough to consider it as regular. But even then, I'm building something of a buffer in my business account to smooth out some fluctuations. We do have some other targeted (personal) savings, and the last time I needed to survive off savings, the entire cash savings account became my de facto e-fund, even though I didn't have as much allocated to 'e-fund' as such.

Thanks for the feedback everybody. I have a credit card with $11K of credit line, and will work on paying down the HELOC until it's empty. Nice to hear various perspectives.

Jimmy

[James]

James,

Another factor is whether your income is predictable or variable. If you 'know' you will be getting a $2,000 check every other week for the next 12 months, your 'emergency' fund can be pretty small (and the higher your savings rate, the smaller the emergency fund needed) since you can count on those paychecks landing in your account.

That being said:
-If you work a more erratic or seasonal schedule (e.g. work on commission, variable hours), you will need more cash in the bank to get you through the 'low periods.'
-If you own a house, you need access to money to pay your mortgage if something happens (liquid, not neccesarily an 'emergency' fund).
-If you own your own business, you will need more cash to stay afloat during seasonal cycles.
-If you are a sole provider, you need a larger 'margin of error' than a dual income household.

But if your salary is predictable, and you make a lot more than you spend, a large emergency fund is an expensive luxury (in terms of opportunity costs) that is slowing down your plans and goals.

Those are good points and I wouldn't disagree, but I would not call most of those items "emergencies".  With more variability there needs to be more of a buffer, and if I had erradic income or payments then definately I would adjust my buffer of cash to adequately compensate during the low points.  But an emergency fund is not for expected variability, it's for unexpected emergencies.  Having said that, many people interchange the idea of emergency fund with the cash buffer they keep, so it's mostly a matter of symantics.

[AJ]

Also, I've never had an issue with a bank revoking anything, and all of them at once?  Maybe if the whole economy collapsed, but if that happened I also wouldn't count on the 1k sitting in an emergency fund.  I don't worry about that tiny possibility.

Yes, but if I remember correctly you're also in your 20s (like me). If there's anything I've learned in the last decade of my life its that old people know stuff. I work for a financial institution, and our CEO does company talks a couple times a year. He has mentioned a few times that the banking industry goes in 20-30 year cycles - just long enough for the next generation to come to their own, make the same mistakes as the last one, and suffer the same consequences.

You may be right, maybe credit cards are ironclad and totally safe. But I don't think it would take a full collapse of the economy for them to be closed. All it would take is the right kind of legislation to pass. To say "well, if that happens we'll all be screwed" is specious. Its like when my in-laws (who live paycheck to paycheck) say that "well, if I lose my job I'm screwed anyway, so why bother preparing."

The whole point of e-funds is for the things you didn't expect to happen. You are (obviously) free to do what you like. But relying on credit cards as your sole source of funds in an emergency is risky at best, and (depending on circumstances) potentially unwise.

[arebelspy]

Yes, but if I remember correctly you're also in your 20s (like me). If there's anything I've learned in the last decade of my life its that old people know stuff. I work for a financial institution, and our CEO does company talks a couple times a year. He has mentioned a few times that the banking industry goes in 20-30 year cycles - just long enough for the next generation to come to their own, make the same mistakes as the last one, and suffer the same consequences.

You may be right, maybe credit cards are ironclad and totally safe. But I don't think it would take a full collapse of the economy for them to be closed. All it would take is the right kind of legislation to pass. To say "well, if that happens we'll all be screwed" is specious. Its like when my in-laws (who live paycheck to paycheck) say that "well, if I lose my job I'm screwed anyway, so why bother preparing."

Re: Credit cards could become unusable.  Fair enough.  Maybe.

Even if I grant you that, it's irrelevant.

There's way more reasons I don't use an emergency fund than credit cards.  Credit cards are like plan C.

The whole point of e-funds is for the things you didn't expect to happen. You are (obviously) free to do what you like. But relying on credit cards as your sole source of funds in an emergency is risky at best, and (depending on circumstances) potentially unwise.

Fine, but they're like a 3rd line of defense because:
1) I've never had an emergency.  I expect I likely never will.  I've found that people that have "emergencies" have them all the time because they just aren't prepared for the randomness of life.  The only "emergency" I could think might happen is a debilitating injury.  One could buy disability insurance if they're worried about that.  I choose to self insure.  Otherwise, I can't think of a single emergency that could happen.  For others, plenty of stuff that happens is an emergency to them.  Car tire pops?  Emergency.  Sick relative in another state they need to go visit?  Emergency. 

All of those things we could easily deal with, and aren't emergencies to us.

2) Cash flow, like I said above.  If we save 5k/mo, we can pay for an emergency just out of cash flow, and not save any that month.

3) Finally, credit cards.  Something big happens, yes, I believe I will be able to charge it if I had to.  I don't think I'd lose access to every credit card instantly and simultaneously.

Numbers 1 and 2 are the big ones.  Credit cards are a very distant afterthought. 

[Ben]

James,

Agreed. Just a terminology difference with the income stuff (I say emergency fund, you say buffer, arepelspy says randomness of life, all meaning very similar things). When it comes to "Proper" emergencies, outgoing expenses and obligations are important, since they influence what you 'need' to stay afloat, and what you lose if you run out of cash.

Don't pay your rent for a few months? You will eventually get evicted and/or break your lease and have to move in with friends or family. Don't pay your mortgage for a few months? You will eventually get evicted, lose your home (and most/all of the principle you have in it), etc.

[AJ]

1) I've never had an emergency.  I expect I likely never will.  I've found that people that have "emergencies" have them all the time because they just aren't prepared for the randomness of life.  The only "emergency" I could think might happen is a debilitating injury. 

Yes, your cash flow will smooth out a lot of life bumps, making smaller unexpected expenses non-emergencies.

What about job loss? That is the big one many people faced with the latest downturn. If both spouses face a job loss at the same time, and it happens to coincide with a credit crunch, what do you do? Its not that far-fetched, it happened to many people in the last several years. Even if one of you lost your job, you would lose your cash flow cushion.

I agree you're in a good position. Actually, you sound like you're in the same position as we are (two steady incomes, could live on either one). But I don't think you can say you'll never have an emergency sitting comfortably in your dual-incomed and child-free twenties. I would be willing to concede that emergencies are for pansies if I heard it from some wise elders who have seen the strategy withstand the test of time, but coming from a twenty-something it just sounds impetuous, and somewhat arrogant.

More to the point, though, I think you do have an emergency fund, you just don't call it that. If I recall, you have six figures of cash you're sitting on waiting to buy short sales with. I'm sure you can and would tap that in a catastrophic emergency. Plus, I know that to proceed with your buy-and-finance-all-the-real-estate-I-can plan, you have to keep 6 month payment reserve for your properties. Its an e-fund by another name that conventional lenders force on us.

Personally, I like to think of my e-fund as an opportunity fund, and I am risk-comfortable enough to go without it for a short time if a good deal came up. But I acknowledge the plan is risky, and I don't pretend that that makes it "advanced" or that everyone should follow it. The fact that our jobs are stable and we have no kids makes risky financial moves less, well, risky. But that doesn't make me "advanced", it just means I'm taking advantage of my youth and am somewhat lucky to work for a stable employer. In another universe/time-line where I have kids and a less-stable employer, I would shamelessly keep a real e-fund. I don't think that makes alterna-AJ less advanced.

[arebelspy]

What about job loss? That is the big one many people faced with the latest downturn. If both spouses face a job loss at the same time, and it happens to coincide with a credit crunch, what do you do? Its not that far-fetched, it happened to many people in the last several years. Even if one of you lost your job, you would lose your cash flow cushion.

Yes, job loss is one risk I will agree with you on.  The wife and I are lucky enough to be at stable jobs that we (very likely) won't lose, and even if one of us did, we can live on one income.  I have stated elsewhere that the stability of your job is one factor in an emergency fund, I'd have one (or consider having one) if I was at a company that was doing rounds of layoffs.

I agree you're in a good position. Actually, you sound like you're in the same position as we are (two steady incomes, could live on either one). But I don't think you can say you'll never have an emergency sitting comfortably in your dual-incomed and child-free twenties. I would be willing to concede that emergencies are for pansies if I heard it from some wise elders who have seen the strategy withstand the test of time, but coming from a twenty-something it just sounds impetuous, and somewhat arrogant.

I didn't say we never will, and any arrogance you see is you reading into it what you will.  I said "I expect I likely never will."  --  It's not impossible, and it may happen, but I literally can't think of a situation that would qualify as an "emergency" that we couldn't handle and would need a bunch of extra cash for.  If you can think of a list of examples, please let me know.  In my opinion, emergencies don't happen when you're prepared and have planned.  Again, my opinion.  You, or some elder people you refer to, may disagree, and that's fine.  Perfectly okay even.   ;)

More to the point, though, I think you do have an emergency fund, you just don't call it that. If I recall, you have six figures of cash you're sitting on waiting to buy short sales with. I'm sure you can and would tap that in a catastrophic emergency. Plus, I know that to proceed with your buy-and-finance-all-the-real-estate-I-can plan, you have to keep 6 month payment reserve for your properties. Its an e-fund by another name that conventional lenders force on us.

Personally, I like to think of my e-fund as an opportunity fund, and I am risk-comfortable enough to go without it for a short time if a good deal came up.

I have some cash for buying opportunities, but if they all became available tomorrow, I'd go to 0 cash.  Ideally I'd be out of cash right now.  Some of my funds recently got deployed, so I'm down to about half that.  Though a rehab is about to close, so I should get a boost from that.  And I'm currently looking into purchasing some notes that will get rid of most or all of my excess cash.   All of that is irrelevant to an emergency fund.  Just because I happen to have some cash for opportunities, I wouldn't call it an emergency fund, simply because I COULD tap it for something.  I expect I never will, and I'd be completely comfortable going without it for long, long periods of time, and wish I was out of cash and invested right now.  As to showing 6 months of reserves, lenders will take retirement balances (401ks, etc.) into account.  You don't need cash for reserves.  If you'd qualify anyone having any money in those as an emergency fund, then sure, I guess most everyone here, including MMM, has an emergency fund.  But the definition we're using is no liquid cash (i.e. springy debt, the title of this thread).

But I acknowledge the plan is risky, and I don't pretend that that makes it "advanced" or that everyone should follow it. The fact that our jobs are stable and we have no kids makes risky financial moves less, well, risky. But that doesn't make me "advanced", it just means I'm taking advantage of my youth and am somewhat lucky to work for a stable employer. In another universe/time-line where I have kids and a less-stable employer, I would shamelessly keep a real e-fund. I don't think that makes alterna-AJ less advanced.

Okay.  I disagree.  If the risk on something is minimal, perhaps almost non-existant, then worrying about the risk seems pointless to me.  Beginners aren't in that position to have the risk minimized, so they need an emergency fund.  Once you get yourself into a position to not need the emergency fund (via stable income, cash flow, springy debt, etc.) then you can make the more advanced move of eliminating the emergency fund, since the risk of not having it is mostly gone, and invest that money.

It seems like we're not going to agree on this, and that's fine.  For me, an emergency fund is pointless.  For others, they definitely need it.  I recently told a friend that should be her first step to digging out of a hole of debt, get together an efund.  It depends on your situation, but, IMO, once you have the risk down in not having an emergency fund... you shouldn't have one.