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

Part 2 Calculating your financial safety net

In part one, titled, “Don’t Just Save for an Emergency, Spend for an Emergency,” we covered how to find your personal beta. This is an estimate (a ballpark judgment) of how closely your job is related to what happens in the stock and bond markets (or the economy as a whole).

If you have a high beta (over a beta of 1), your financial well-being is in danger of sliding even faster than a down market. If you have a lower beta (under a beta of 1) your well-being will not be so adversely affected by a downturn. A beta of zero means what happens in the economy won’t affect you at all. A beta of 1 means you are likely to experience the same kind of thing financially that is happening to the stock/bond markets.

You can also follow Dr. Moshe A. Milvesky’s advice and figure out whether you, as a form of human capital in the labor market, are more like a stock or a bond. This little game too can help you begin to think about how much of a financial safety net you need to build for yourself. Once you know how likely you are to be impacted, and how heavily, by a downturn, you can estimate how soon and how much money you’ll need to have for your safety net.

Back to Suze Orman’s advice

Suze Orman suggests we all save a total amount equal to  six months of our typical monthly income to live on during a downturn. In my previous post, I pointed out what this is not a sufficient enough action for many of us to take. Many Americans are just now digging out after as much as two-years of unemployment or underemployment. We need a better way to survive future downturns!

What Dr. Milevsky’s approach to building a safety net got me thinking was: the smart thing to do after you identify your personal beta score, is to create a safety net not just through accumulating savings, but also through purchasing assets — against which you can borrow in an emergency.

With these kind of “renewable” assets you can get money for an emergency, and still hang onto your assets too, i.e., you still own the asset you borrow against. I don’t know what the technical name for such assets is, but I’ll call them “renewable assets.” That term means that after you use up some of the value in these assets by borrowing against them, you still have a valuable asset available for you to use while you rebuild it. This means that later on in your life, you can reuse your assets by borrowing against them again.

Putting your savings into renewable assets over a long period of time will provide you with a real safety net when the crunch comes. All you have to do each time is pay back what you borrowed against each of your assets. In other words, your money isn’t completely “gone, baby gone”. You still have something that’s potentially valuable left in your possession. These assets remain valuable because they are “secured” debt. Secured debt is a derivative. It is a bank (or a credit union) loan derived from an underlying asset that you own.

What kinds of renewable assets are best?

Houses and credit cards have been the assets of choice for most working and middle-class Americans who needed to borrow money for short spells of time. During good times (or what some people are now calling “bubbles”) these assets can be used for entrepreneurial projects to “get ahead” a little and build a safety net.

But these days many people cannot borrow against their houses. And at any time, upturn or downturn, the rates of interest on credit cards are sky high. They is because credit cards are “unsecured” debt, meaning there is no asset behind them that you can sell. High interest rates make credit cards dangerous to borrow against for too long a time.

Assets that are usually smaller, but much better to build a safety net with, are things like a new or newer car and life insurance.

The nice thing about a newish car is that you can use it while you borrow against it. All you need to borrow against your car, is  that the car has enough value (or “equity”) over the amount you still owe on it, that it can serve as collateral for your second loan from the bank or credit union. Life insurance too is still in effect while you borrow against it, working on your behalf, (although at a lower payoff if you were to die).

Because these are secured debts, cars and life insurance often have low rates of interest and looser repayment terms — sometimes with no penalties for late payments. For some of us, life insurance can be a better asset than a car because some life insurance policies pay dividends which you can automatically reinvest to buy even more life insurance on yourself. For others, a car can be a better asset because you may not have anyone to leave money to or because you use the car in order to make an income for yourself. With any asset purchase, the decision has to be based on what is best one for you at the time.

The role of your credit rating in spending for an emergency

When it comes to credit ratings, I’m in total agreement with Suze Orman’s advice. In fact, I’m most grateful for all I’ve learned from Suze about this topic as well as for her helpful financial planning and organizing kits. Even though you can’t sell your credit rating, your credit rating remains one of your best assets. That’s because of how much it saves you when you spend with it.

Even when you are not be able to use your credit rating to get a loan from a bank, you can use your good credit rating to buy reusable assets which you can borrow against when you need to. And the better you credit rating is, the less you’ll pay to buy renewable assets such as a house or a car.

Nurture your credit rating. A high credit rating will often enable you to pay lower interest rates on practically everything you buy or rent.

As soon you get equity in a car (i.e., the car is worth more than the amount of the loan left to be repaid on it) you can usually borrow against that car. Some cars retain their value longer than others after being driven off the lot. So shop carefully.

Think too about buying life insurance. You have to get the right kind of life insurance to be allowed to borrow against it. Ask about borrowing terms and conditions before you buy a policy. Often a local public library will be a great source of information for you when shopping for assets you can borrow against.

Then comes the hard part. Make your payments on time! You need to keep your good credit and accumulate enough equity in your renewable assets to borrow against them the next time you need to.

How to calculate your financial safety net

Here’s what I suggest. Sit down right now and calculate your (1) total savings, (2) your total credit card(s) limit left that you could spend, and (3) the total amount from loans you could take out on any assets you own, such as life insurance, investments, your car, and/or your house. Add up the three totals. Your grand total will show you just how long you can hang on if catastrophe hits.

Bear in mind, that as you run up a credit card or home equity loan, your interest rates will probably be raised and/or the bank or credit card company may lower your credit limit. Also, insuring your assets will cost you a bit more money, but you’ll need to to have kept your assets well-insured so they’ll be there when you have to borrow against them. Lastly, diversify your emergency assets to protect yourself somewhat from loss of of any one of them, i.e., buy different types of assets from different companies.

If you’re uncomfortable with the total amount you come up with, just congratulate yourself on being realistic. Then start figuring out how you can find and afford diverse assets that you can borrow against in an emergency!

What if you don’t have any money at all? You might look around and see if there’s anything in the clutter in your home or office that you can sell in order to start buying assets for an emergency. Also, see if Kim and Robert Kiyosaki’s advice about paying down credit cards in the quickest amount of time possible can work for you. At the very least, even if you are out protesting in the financial districts of the US, create a plan for when you’re able to make and spend a little more money again.

Once you begin spending on assets for an economic emergency, periodically recalculate your financial safety net. Things change. Interest rates go up. Your living expenses may increase or decrease. Your health may be different than it was. Make sure your safety net hasn’t developed holes in it while you haven’t needed to use it.

Building a safety net that won’t be depleted in just a few days or weeks will take time and patience, and you’ll be glad you have that net when you need it!

Follow Nancy Humphreys on Twitter @brucenomics