Emergency Funds: Cash vs. Credit
I’ve always viewed the emergency fund as a self funded insurance policy designed to protect me and my family from unexpected expenses or to cover us for a period of time should my employment be interrupted. The only real differences between risk based policies sold by insurance companies and a self funded policy is that with self funded policies your premiums stop once your policy is fully funded, your premiums are not jacked sky high if you make a claim, and your funds are accessible at any time for any reason. Like any insurance policy you expect to access the funds when an event triggers the policy to pay out and with a self funded policy you must ensure that you can get access to your funds in a reasonable period of time.
Once enough has been saved for the emergency fund, many people choose to keep these funds in savings accounts, money market funds, treasury bills, or even certificates of deposit. My question is why should these funds remain in very short-term instruments that have such low returns when you already have a line of credit as an emergency fund?
By keeping emergency funds in savings accounts or short-term investments your capital is tied up capital in low rate of return investments. With the effects of inflation, you run the risk of having the purchasing power of your emergency fund actually decrease over time.
An Alternative: Line Of Credit & Cash Invested
If you need to establish an emergency fund, why not set up a line of credit as your emergency fund and then systematically invest your contributions into mutual funds, stocks or bonds?
The contributions should be treated like an insurance policy premium and made regularly. The investments will be subject to the market and should generally earn better returns than savings accounts or CD’s. If you have a short term cash need, draw from the line of credit and pay it back immediately. If you emergency need is longer-term you can cash in your investments and pay the line of credit.
The Risk
Since the investments will be in variable return securities, there is a down size risk that the market may go down and your investments may lose value. However, if you plan for a market decline in your investment strategy, you can hedge that risk as well.
Resources
- Million Dollar Journey - Opportunity Cost Of Having An Emergency Fund
- Wise Bread - Things to Insure, Things Not To Insure
- Accumulating Money - Setting up an Emergency Fund
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- Should I Buy Insurance?
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- Why Life Insurance?
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Best of PMT
Top 10 Sites Referring Visitors to PMT
Here is a list of the top ten sites visitors to PMT came from in the lat thirty days.
- Stumbleupon
- Quest For Four Pillars
- The Digerati Life
- The Simple Dollar
- The Skilled Investor
- Million Dollar Journey
- My Dollar Plan
- All Financial Matters
- Get Rich Slowly
- Five Cent Nickel
Welcome to all my new visitors.
Here is a list of the top ten articles:
- Why Down Markets Are The Best Time To Buy
- 10 Everyday Tips to Save Money
- Budgeting vs Cash Flow Planning
- Multiple Bank Accounts Help Manage Your Money
- How To Create A Financial Plan
- Up To Your Eyeballs In Debt
- Tips To Reduce Credit Card Debt Problems
- Household Net Worth Planning: The Cornerstone Of Personal Finance
- Simple Strategies to Pay Off Your Mortgage
- Plan Your Savings
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- Signs of Financial Trouble
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- Household Net Worth Planning: The Cornerstone Of Personal Finance
- How To Create A Financial Plan
- Favorite Blogs Of The Week
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Article Round-Up
Here is a round up of some my favorite article’s from the last few weeks.
- Get Rich Slowly - The Story of Stuff
- The Simple Dollar - Sixteen Ways to Go Out on the Town on the Cheap - Tips to be social without going broke!
- My Money Blog - Calculating Life Insurance Needs: Capital Needs Analysis - How do you know how much life insurance you need?
- Canadian Capitalist - How Much Life Insurance Do I Need? - Another spin on the topic.
- Blueprint for Financial Prosperity - Realistic Hypermiling - I’ve tried some of these tips and they might just work.
- Consumerism Commentary - How I Could Find $10,000 Per Year if Necessary- I cut out some cable channels!
- Five Cent Nickel - How Many Bank Accounts Do You Have?- Hmmm.
- Million Dollar Journey - Hybrid vs. Gasoline Vehicle Comparison - Are Hybrids Worth it? - Perhaps.
- Digerati Life - 7 Compelling Reasons Why Long Term Investing Is Better Than Short Term Trading
Related Articles
- Best of PMT
- Weekly Round Up: June 21, 2008
- 10 Everyday Tips to Save Money
- Emergency Funds: Cash vs. Credit
- Why Life Insurance?
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Having A Night On Out Cheap!
This morning I received my credit card statement and below the total and the summary of my rewards points was just over 15,000 points. I’ve said before fee free credit cards that offer rewards points are an excellent type of card (the interest rate should not be an issue if you pay the card in full…and I do every month!) but have never really cashed in my points for anything other than airfare upgrades.
I decided to take a look at the other rewards available for 15,000 points and while I was at it look at the rewards available on my other point cards. Here is what I managed to get for a year’s worth of points accumulation:
- $100 gift card to any restaurant. I’ll take my wife out for a night out and we can probably afford to do a little extra!
- $50 gift card to my favourite book chain. I love books and you can expect some book reviews in the near future.
- $50 iTunes gift card. A little something for my daughter who loves her iPod (she doesn’t read my blog so it will still be a surprise).
Related Post
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- Tips To Reduce Credit Card Debt Problems
- Featured Credit Card: American Express Blue For Business
- Signs of Financial Trouble
- Up To Your Eyeballs In Debt
- Mortgage Update #2
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My Thoughts On Real Estate Investing…
Your financial objectives should drive your decision. As a general guideline you need to determine your long term financial goals first and then structure your investments to help you achieve your goals. If you are thinking about whether you should keep your current home and rent it out and then buy another in my opinion is putting the cart before the horse. Determine your goals first and then see if the rental property is worth while.
My thoughts on real estate investing…
While real estate investing is a valid endeavour you really need to consider if the amount of time you plan on putting into it is worth the risk associated with the investment. The risks of real estate investing as I see them (and this is not a comprehensive list) are:
- Liquidity. Your capital is tied up in property that is not liquid. Should you run into a cash flow crisis you could be forced into foreclosure or bankruptcy even though you have a large net worth. To mitigate this risk you will need to reduce the amount of leverage you have (i.e. but as much down on the properties as possible).
- Vacancy risk. There may be periods where your property may be vacant and you need to plan accordingly to service the property regularly and keep any financial commitments on the property.
- Maintenance risk. Real estate needs maintenance. Over the long term this can and will cut into the value of your property and affect your cash flows. If the value of the property increases over time, remember that you will need to make periodic upgrades to help improve the value as well.
- Tenant risk. You can do all the due diligence in the world but there is still a risk you can have a bad tenant that will not pay or worse could trash your property. Tenants don’t own the property and may not be motivated to care for your property.
- Market risk. Your property value is subject to market conditions and the value of your property can fluctuate over time. Generally, the longer you hold the property the better but values may decrease in the short term.
- Personal time risk. This is one type of risk many may not consider. In some cases the amount of time you spend on your rental property doing maintenance, paying bills, searching for tenant, keeping financial records and doing your taxes may be more than you bargained for. This is not to say that this type of investment will suck all of your free time, but think about how much time you want to invest and how much time you think these activities will take.
- Opportunity cost. Simply stated opportunity cost is the risk that you could have invested your money elsewhere and achieved a better return. That is to say are you better off investing in the stock market or real estate? And are the projected returns better over time?
Finally you should consider your annualized after tax return on investment in the real estate and compare it to the after tax return on investment on a portfolio of all equity securities. In most cases you’ll probably end up earning more in percentage terms on the market portfolio simply because the cost to maintain the property eats into your returns. Build a spreadsheet and compare the alternatives.
Related Articles
- How To Create A Financial Plan
- Household Net Worth Planning: The Cornerstone Of Personal Finance
- Four Quick Ways to Increase Household Net Worth
- Budgeting vs Cash Flow Planning
- Emergency Funds: Cash vs. Credit
If you have found this article useful or simply enjoyed the reading and would like to have more personal finance related articles delivered to you directly, you can subscribe to Personal Money Tips by e-mail or to your news reader.
