One of the good feelings when you have a blog is when people link back at one of your article. I always look at the blogger who linked to my post. It is usually very positive. Usually. Two days ago, when I logged into my blog to post updates, I noticed that one of the link was called “I think this is bad money advice”. I thought I would give a little bit more interest into this post written by Ana at Debt Free Revolution.
Four Pillars brought a good argument on his blog yesterday and I’ll bring another one today as well.
Let’s take 2 people again, Mike (it’s not my fault if FP and I both have the same name 😉 and Ana. They are both making 50K and wish to have 25K available in case of an emergency (6 months salary). They also have the ability to save $377 per month and both wish to retire in 30 years.
If Ana wish to have a 25K emergency fund, she would need to invest $377 per month over five years at a 4% rate of return. As this account needs to be highly liquid and the investment must be stable overtime, I assume that the maximum rate she could get would be a 4% savings account at ING. If she would be to invest in more aggressive mutual funds or stock, she would become very dependable of the market and this is not what we want when we are looking for an emergency fund.
After 5 years, she leaves the 25K into the same savings account earning 4%. She can now use the $377 and invest in a more aggressive portfolio (giving 7%) since she will be retiring in another 25 years. At retirement (so 30 years later), her 25K into her savings account is now at $66,6K and her retirement account show a balance of 305,4K for a total amount of 372K.
Mike doesn’t want to save for an emergency plan as he will use his HELOC if he has any problem along the way. Then, he starts investing his $377 at 7% right away. At the end of the 30 years, he will have 460K into his investment account.
So if you depend on a HELOC for your emergency fund, you will get $88,000 in your investment account at retirement. This is the equivalent of 50 years of interest on $25,000 debt at a 7% interest rate.
So I think that everything goes well, you will make 88K more by not having an emergency plan. If you have to withdraw 25K from your line of credit, it will cost you $1,750 per year at a 7% interest rate charge.
Ana was also mentioning death and severe injuries in her post. These incidents should not be covered by an emergency fund but by insurance as 25K will be far from enough to cover for the financial lost of your spouse’s income.
Please note that this was a quick calculation. In order to be precise, I would have to calculate when and for how long Mike and Ana would need their 25K and also to take in consideration that the tax rate would be higher on the interest earned in the savings account than the investment account (which would include mostly dividend and capital gain).
image source : www.saltlakespeaks.com
|How I Suck at Not Paying Debts||Hitting 6 Figures Income at 28|
|How I Get a Huge Income Raise Each Year||Making $125K Online in 12 months|
|How I Buy Blogs||Most Debated Articles: The Primerica Saga|
|How I Have Survived My MBA||What is So Wrong With Making Money?|
|How I run multiples blogs and makes money without burning out|