Last week I had a $400 emergency. Actually it was more like a $513 emergency, and was left-out of work for two weeks. Fortunately I’m prepared for a situation like this, because I’ve been funding a small emergency fund. And therefore had to withdraw some money from it. Last year, it was reported that an average of 34% of respondents with an income less than $40k/year would be able to cover a $400 emergency. Which means paying in cash, or using a credit card that’d be paid off by the end of the month.
The average number of respondents who reported being able to “handle the emergency” was higher along higher income brackets (e.g., of those making $40k – $100k / year, 62% responded in this way). Which means that 38% and a full two-thirds (i.e., 66%) of individuals last year, earning between $40k – $100k and ≤ $40k respectively, reported being unable to handle an emergency expense totaling $400. Furthermore, being unable to handle such an emergency expense was related to putting it on a credit card, and paying it off over time, borrowing money from friends and/or family members, or just not paying the expense all together¹.
The age old question of how to allocate available income is best resolved by either paying off pre-existing consumer (credit card, car loans, etc.) debt, and/or investing for the future. Presumably, when we speak of investing the most popular way to accomplish this is through stocks and bonds. But how much to throw at debt, and how much to invest is often under debate. Are there fixed percentages that financially responsible individuals use (e.g., 85:15%, 60:40%, etc.)? Can we just add an extra $100 on top of our minimum monthly payments and live with that? Does investing in asset classes that average a certain percentage of return justify putting our dollars there [e.g., if I can confidently assume a 9% rate of return year-over-year (YOY) but my car loan interest rate is only 6%, I should choose funding that particular asset class]?
All of these questions will be explored, and more, in this article. But first, it’s worthwhile mentioning that no two snowflakes are identical. And thus, not everyone will have the same savings strategy. Although the strategies contained herein may be effective for some, and not others, the basic idea(s) are almost universal. So take what you can from me, and absolutely feel free to tweak according to personal preferences.
Now, let’s go tackle some debt.
What does having no credit card debt feel like? Like discovering an oasis in the middle of the desert. How do you get to that point?
You need to make much more than just the minimum monthly payment. And I have transferred big chunks of my balance to low interest credit cards. That means more of each payment is going towards the principal balance, instead of interest. But that wasn’t always the case. Read more