Don’t Just Save for an Emergency, Spend for an Emergency!

Perhaps you recall my first post about Suze Orman, “Broke and Broker: My Week at Suze Orman’s Merrill Lynch“? Well, here I go again.

TV personality, Suze Orman, is fond of advising listeners to keep enough savings in the back to live on for six months.

I think this is about the dumbest advice I have ever heard from such a smart person!

First of all, many American workers simply can’t do it. Why not? Because wages in the US have steadily declined over the past 40 years. Many homeowners are underwater; and some are unemployed or underemployed on top of that!

Small businesses have been dropping like flies over the past three years. Big corporations can get bank loans, but small businesses cannot, even if they had enough demand to dare to expand. Self-employed professionals and entrepreneurs are struggling too. Who can save six months worth of living expenses?

But here’s the thing. Even if you could save up for six months of living expenses and put it in the bank, why would you do that? Once you lived on that money for six months it would be gone! Gone! All gone! And you’d have nothing at all to show for it.

Spend down your savings, and you’d have to start all over from scratch to build up your safety net again. That’s why I think Suze’s advice is the dumbest I’ve ever heard.

I can see a better way that is still available to some of us 99% to build a safety net right now. First of all, calculate your “personal beta”. Second, calculate the size of your existing safety net. If it isn’t high enough, start spending on the right kind of assets to have for a financial emergency. We’ll cover calculating your personal beta today, and calculating your safety net in the next post.

Are you a stock or a bond?

A “personal beta” is the brainchild of  Dr. Moshe A. Milevsky, professor at the Schulich School of Business at York University in Toronto. In his article, “How to Think Smarter About Risk” in the Wall Street Journal last June 14th 2010, Dr. Milevsky advises you to think of youself as an “investment” and calculate your own personal beta.

That novel idea stuck me as funny and intriguing. A beta usually refers to a stock or a bond. A beta is a measure of an investment’s returns in relation to the returns of the market as a whole.

A beta of 1 means that the investment moves in tandem with the market upwards or downwards. A beta of 2 means an investment’s returns will be worse in a downturn or better in an upturn than the market’s returns as a whole. A beta of zero means your investment is totally independent of what goes on in the market. Whatever happens in the market won’t affect anything for you.

Knowing your personal beta is essential for knowing what might happen to you and planning for the kind financial emergency Suze Orman is thinking of when she admonishes us to save six months of salary.

If we think of ourselves as an “investment,” such as a stock, with a particular beta of our own, we can easily see that being independent of the swings in the marketplace is also the end-goal of Suze Orman’s advice – when Suze encourages us to put six months savings in the bank, she wants us to be secure against the vicissitudes of the markets and the economy in general.

The two basic problems with Suze’s approach to security are these. First, downturns (and upturns) affect everyone differently. Secondly, who knows how long a down-trending market cycle will be?

Right now many people are likely to have been unemployed for up to two years or more. We all know it may be awhile before the job market picks up. Likewise, small businesses and solo practitioners always need to be able to ride out a dry spell for an unknown period of time. As we’ve just seen, that dry spell can extend into years. Without government support through dry spells, especially very long ones, most of us are in some kind of trouble.

Here’s what Dr. Moshe A Milevsky wants you to do: he wants you to think about how a stock market plunge would affect not only your portfolio (if you have one), but also to “think about how such a drop would affect your paycheck and your career.” He calls this thinking a form of “personal risk management”.

How to calculate your personal beta

Moshe’s article about calculating your personal beta is both cute and fun. He challenges you to begin by deciding whether you are more like a “stock” or a “bond”. You are to think of yourself as “human capital,” and imagine that your paycheck (or business income) is the dividends on your human capital. To estimate your beta, he suggests you estimate how much your job is likely to change with any change in the markets. Ask yourself, how much is your job affected by what goes on in the marketplace?

He uses US Supreme Court Justices as an example. These government employees have a beta of zero. Nothing that happens in the economy is likely to affect the need for their services or their salaries. But my profession, back-of-the-book indexing, is quite different. Indexing is highly sensitive to what goes on in the stock market.

Holidays and school terms impact book publishing. During downtimes checks from publishers come in way more slowly. Being paid takes months or in rare cases years, rather than days or weeks. Fears at the  millennium about the computer-programming glitch from using two-digit figures instead of four-digit figures for the year in dates, caused publishing to come to a near-halt in autumn of 1999 as book manufacturers held their breath to see what the economy would do if all the dates in computer software could not be re-programmed in time.

Over the past decade, changes in the publishing industry have been phenomenal. There has been a huge amount of consolidation and globalization in the publishing industry, and it has changed the way the book publishing business operates. There have also been major technological changes. (If you’re interested in reading more about this, please download my free, three-part, special report, The State of the Publishing Industry in the 21st Century.)

Long before Dr. Milevsky’s article came out, I was intuitively calculating my personal beta. As a result of seeing what was happening in the traditional book publishing industry, I shifted my business model a few years ago. I decided to focus more on serving self-publishers and independent publishers instead of trying to keep up with the changes at traditional publishing houses. As a writer who was part of the “mimeo revolution” decades ago in the 1970s, I was more than happy to join the new version of “underground publishing” taking place now.

Before we get to thinking about whether your safety net is high enough, I encourage you to read Dr. Milevsky’s article online. Calculate where you and your career are at. We’ll take it from there in my next post about what’s the best way to spend for a possible financial emergency.

Next time: Part 2 of this series: Spend for an Emergency, Don’t Just Save for an Emergency

Follow Nancy Humphreys on Twitter @brucenomics