Here’s some advice you hear over and over….build up your emergency fund first, even before paying off debt.
Are you kidding me?
Let’s do the math: if you’re paying 21% interest on a debt and it takes two months for you to build up Dave Ramsey’s $1,000 as the first step to your cash reserve, you’re letting a ton of interest accumulate on your debt. Additionally, that money you’re saving? It’s netting you somewhere in the range of .01%…if you’re in an interest bearing account at all.
Additionally, why put this money away in the first place? If you’re paying 18% on a credit card, why the hell aren’t you paying every dime toward getting rid of that debt? Something bad happens, what do you do? You just put the money back on the credit card.
It’s just plain math.
So why do people recommend an emergency fund?
Because life isn’t about math.
Did I have you on the “screw the emergency fund” train? Well…that was my goal, but I was messing with you. While I can appreciate the math above, I think there are many factors at work that make me, among many others, recommend building your emergency fund rather than investing the money.
As someone who’s counseled hundreds of people toward financial success, I can say unequivocally that you need an emergency fund.
– I don’t care what the interest rate on your debt might be. You need an emergency fund.
– I could care less how “nothing is going to come up.” You must build an emergency fund.
– It’s irrelevant how much cash flow you have or how great your credit might be. Go build your emergency fund. Now. Before doing anything else.
Emergency funds aren’t about math.
To help you understand just how incredibly misguided people are who advocate NOT building an emergency fund, let’s take you through another example. This one isn’t about math. It’s an example about human nature, real-life situations, and utility:
Jim-Bob has $20,000 in credit card debt. He’s been trying to pay it off for the last five years, but whenever he gets close to having it paid, something happens. His muffler is dragging behind the car. His dishwasher breaks down. Life happens.
Here’s the magic behind building your cash reserve first:
1) You can pay every dollar toward your debt, but then you have to make sure nothing happens while you’re paying off the card. How many times have you NEVER had anything happen to you during a three or four month period? Ha! Of course stuff happens! Life hits you from out of the blue! Woody Allen is right: “Life is what happens when you’re busy making plans.”
2) If life DOES happen and you take out your credit card, what are you really doing? You’re teaching your subconscious mind that it’s okay to use this debt in an emergency.
I’d submit that this is the biggest part of the problem. We think that “It’ll be okay just this one time.” It isn’t okay. A credit card isn’t your money. You’re using someone else’s money to solve your problems.
I believe that the first step toward independence is to make yourself independent. Right. F-ing. Now.
Stop borrowing from the credit card company. If real life jumps up and grabs you, teach yourself to stop turning toward the credit card. You’re better than that.
3) Finally, your emergency fund helps you build another muscle: the “saving is the most important part of the equation” muscle. People often pay off debt and then find themselves like a boat in the ocean without wind. They have nowhere to go. That’s why the next point is critically important:
Paying off debt isn’t a goal. It’s a hurdle.
When I first switched from financial planning to blogging, I let people fight me on this point. One of the same bloggers who fought me (because his blog was all about how he was paying down his debt) struggled immensely after he paid down his debt. Don’t listen to people who haven’t been there before: you need to see debt as a hurdle, not a goal. If you have nothing on your mind beyond paying down your debt, you won’t succeed. Period.
I totally get that achieving debt zero is an important milestone for people. But when you make it a goal and spend every dollar toward paying debt without thinking critically about real life, you’ll make the mistake of avoiding an emergency fund and instead then wallowing in debt long term. I don’t agree with Dave Ramsey on every point, but on this one I’ve seen eough success to tell you point blank:
Build your emergency fund right now.
Disagree? Let’s hug it out in the comments below.
Joe Saul-Sehy is the co-host of the Stacking Benjamins podcast and writes at The Free Financial Advisor – Average Joe’s Money Blog.