Money Obedience

Money is part of life, but it is really not the most essential part of life, is it? Let me make the point by talking about financial emergencies and preparing for emergencies, a favorite topic among personal finance bloggers.

It is a favorite topic because it is so very important. Life is full of unforeseen events. If you are somewhat prepared for surprises, you will probably weather almost any storm in pretty good shape. I don’t want to get into the details of how much money you should set aside for financial surprises and emergencies, since that would be a topic for at least one other post. Instead, I want to state that it is not that difficult to set aside some money for financial emergencies. All you need to do is put a little money into a savings account every month and before you know it, you will have a sizeable sum of money socked away for emergencies. Easy, right? – Well, some of us have difficulties doing that. Not that I would blame anybody who does not have an emergency fund, since life’s expenses and desires can indeed get in the way. Still, the idea of putting money away for emergencies is pretty simple and it can be put into practice fairly easily, too, right?

We cannot say the same about other emergencies and surprises in life. What about illness? What about the terminal illness of a loved one? There is nothing we can do to prepare for personal emergencies like these. Even when we are prepared for the death of a loved one (for example, in the case when doctors may have told us a few months prior), we are still not prepared. There is nothing that prepares us for the finality of death. No emergency pile of happiness will make up for the sadness we feel in life sometimes. And this kind of sadness hardly ever centers around or involves money, does it?

So, considering the real emergencies and surprises in life, doesn’t it look so much easier to prepare for financial surprises and emergencies? Somehow we can almost always get a handle on our money situation. So, if you’re lucky enough to have food, clothing, and shelter pretty much set, then why not focus on setting up an emergency fund? Why leave yourself open to financial surprises and emergencies? Life deals us plenty of surprises and emergencies for which we cannot prepare adequately no matter how much advanced notice we get. Let’s make sure that we at least somewhat control those easy-enough-to-deal-with financial surprises and emergencies.

Donald Cole, an historian, talks about his life experiences in an interview entitled “The Power of Adaptation.” At the end of this interview it says, "Money makes a difference to a point, and after that there are very diminishing returns. People in abject poverty are less happy than people who are modestly well-off, but people who are modestly well-off are not less happy than very rich people."

What conclusions can we draw for our own personal finance from his statement? I think it is pretty clear that we need to focus on, first, avoiding dire poverty, and second, our meeting our basic needs. But the conclusion is that as long as we can keep ourselves and our loved ones warm and fed, it should not be so far a stretch from there to be able to lead a fairly happy life. So, for example, when we employ a retirement planning calculator or a net worth calculator, we should really make sure that we are setting ourselves up in a position that allows us to cover our basic needs. This in turn allows us to lead a happy life, if that is what we really want to pursue. The point is not to seek out a lot of money for luxuries, for having it in our retirement account or in our net worth will not add a great deal to our happiness.

Did you hear the one about the two boys who received gifts in their Christmas stockings? One got an expensive gold watch, and the other, horsecrap. On Christmas morning, the one with the watch was anxious - how could he be responsible for such a valuable and delicate thing? He vowed never to touch it just in case he'd break it. The other boy was ecstatic, and shouted "Santa gave me a pony! Now, all I have to do is find it!" In a way, this joke expresses what I'm driving at here. First, riches do not bring happiness, and second, gaining access to life's joys can be a matter of perspective.

Which brings me to another thought: Sometimes we may be too focused on money issues which can actually become the source of unhappiness. This can happen even if our economic well-being is not necessarily in jeopardy. Money and the luxuries money can buy can become another excuse to feel unhappy about yet another thing.

Don't get me wrong: money can also be the excuse to feel good, as long as you have sufficient amounts of it. I have known many happy people who were not that well off economically, and I have known at least as many people who have a bunch of money but who don't appear that happy to me. I know from my own life during which my income has fluctuated a bit that these fluctuations in income have never had a severe impact on my happiness. Sure, I did not feel so good when I made a bit less money after having made a lot the year before, but I never got to the point that my economic well-being was in danger. Besides, whenever I had a good year, I knew that it might not last and that I should not base my life style on such a higher income. When a worse year rolled around, I was not caught off guard. I still felt blessed that I had a great income the year before. This attitude has allowed me to adapt easily to new circumstances, especially a lower income. And the ability to adapt seems to contribute to my happiness much more so than a few thousand dollars extra in my bank account.

Let me ask you now. How well do you think you can adapt to new circumstances? And more importantly, what actually contributes to your well-being? What is important to you?

We all know that we need to save for some unforeseen emergencies like health expenses or unemployment, but we are often lost about the amount we need to save. So, how much should we save? As with so many things in personal finance, there is not one number that fits all. As a matter of fact, there is not even an exact amount anyone can calculate for him- or herself. Often, the best we can do is to find a range for which we might aim.

One useful rule of thumb is that you put away between 3 and 6 months of your monthly household expenses for emergencies. This is a pretty wide range. Actually, most of us are saving at that range already, without even knowing the rule.

Still unsure of which end of the range to aim for? You can narrow down your target a little depending on your personal circumstances. For example, find the answers to the following questions. Is there only one breadwinner in the family? How many kids are in the family? How old are the children? How secure is your income? Answers to these and similar questions will let you know how vulnerable you are to losses in income – and the more vulnerable you are, the more you may want to aim higher (or for a greater number of months of replacement income).

There are other rules out there that people think are useful here. Some say that we should set aside at least $1000 for emergencies. That seems like an odd number to me. What good can $1000 do? You will not be able to financially survive a real emergency like high hospital bills or long term unemployment on that figure. At least I know that $1000 would not make much difference to me – but I am one to always prepare for the worst-case scenario, and my worst-case scenario comes with a much higher price tag. Still, $1000 is better than nothing. If you’re at the $1000 with your rainy-day fund, it is a great start as a down payment for a larger future emergency fund.

Yet another idea is to add one month’s expenses to your emergency fund for each 1% increase in the unemployment rate. That way, if unemployment is high, you save more, on the assumption that you are more likely to dip into your savings if you lose your job because it will be more difficult to find another one. This sounds like a pretty good idea, generally speaking. But what if you’re one of the first ones facing job losses when the economy has a downturn? You wouldn’t have enough time to respond to the up-tick in unemployment rates because you’re one of the folks contributing to that up-tick! Thus, there’s no way this strategy can work for everyone. You’d have to be one of the lucky ones who kept his/her job when things got dicey in the labor market. And in the current environment you would have to save pretty aggressively to keep up with the quickly rising unemployment rate.

Even though there is not one single correct solution to this problem one thing remains the same. Emergency savings are meant for, well, emergencies. You cannot know what type of emergency will strike, or when it will occur, which is why you must be prepared. Being prepared surely worked for me. I have less than 9 times of monthly expenses in my emergency fund, but it helped to have that much, because I lost my job and had no time to respond to the increased unemployment rate because I was one of the statistics, as they say. And now I am working for less income than I did before, which does not allow me to boost my emergency fund aggressively to keep up with the still-rising unemployment rate. But this does not matter, since I was prepared before a financial emergency hit me. And that is really what it boils down to. There’s no “one size fits all” here. You just need to be prepared for financial emergencies in a way that works for you individually. Be sure to think about it before the emergency strikes!

In the area where we live spring has arrived. The crocuses and daffodils are in full bloom. The tulips are coming through. The grass is getting greener.

When we look out of our bedroom window we see trees budding now. Soon we will have full green foliage in front of that window that will change to bright yellow in the fall. This is one of the reasons why we love our home. It is not the biggest in the neighborhood, but it is not the smallest, either. It is just our home and we enjoy it.

While our house gives us lots of pleasure, it also gives us some headaches. The work we have done in a few years of ownership seems almost endless. We needed to fix the chimney, reinforce the foundation to control basement leaks, replace the roof, paint the house, get a new driveway and walkways, and so on. And this is just a short list of the maintenance we had to do. Never mind the upgrades.

The other headache is the state of the housing market. We are also fortunate enough that we have a good equity cushion in our house, but if prices drop way below trend (that is below the prices of 1996), we may end up owing more on the house than it is worth. That would not be good.

The bottom line of all this is that we view our house not so much as an investment but more as a home. This is where we live, this is where our little children grow up, and this is where we feel comfortable and happy. Isn’t this exactly how it used to be? A house was a family’s home. It often was also a source of wealth but mostly because the mortgage was being paid off and not refinanced. People did not used to refinance their homes over and over, they did not take out “equity,” and instead they dutifully paid off the mortgage on their home. At the end of the mortgage, they owned their homes free of any debt. That was the source of wealth.

We do hope that others will join us in going back to “housing basics” and that we will all look at our houses as homes again. This will make us all more responsible with the way we treat our home. We will be careful not to lose our homes and we will not engage in crazy house financing schemes that banks were all too willing to push on many of us in years past. We hope that this is the most important lesson that follows from the mess in which the housing market is right now.