This Popular Financial Tip Will Cost You $1 Million
We know bad things (and often unexpected things) happen to good people. Sometimes we need to get out of a jam, and money can help. If you lose your job, it's nice to have a cushion to pay the rent and buy food. It's important to have the ability to pay high medical deductibles if you get hurt or sick. If you get a flat tire on the way to work, you need to be able to get it fixed and back on the road. Stuff happens, and money is often the only salve.
An Old-Fashioned Location
The Certified Financial Planner Board would strip me of my certified financial planner designation if I suggested it was not important to have an ability to cover these emergency situations. But the antiquated six to 12 months in a checking account or money market account is a terrible idea.
Consider a 30-year-old couple. They're doing their best to save for retirement and raise a family. They calculate that 12 months of living expenses is $75,000. Like good students, they follow the standard financial advice and set aside $75,000 in a savings account at a bank. After a few high-fives, they go on about their lives feeling good about their "smart" financial decision. It's too bad, though -- they just cost themselves $1 million.
Here's the math:
|Traditional Emergency Reserve||Alternative Emergency Reserve|
|$75,000 in savings account||$75,000 in diversified investment portfolio|
|1 percent interest rate||8 percent investment return|
|35 years (until age 65)||35 years (until age 65)|
|TOTAL: $106,245||TOTAL: $1,108,900|
The difference between the emergency reserve savings account and the alternative account is a whopping $1 million!
The "alternative emergency reserve" is simply to invest the cash in a diversified investment portfolio. But hold on, you say. Where's the rainy day fund when you need access to money quickly? You absolutely should have access to assets, cash or some way to cover these emergencies -- but there are many other sources you could access that won't cost you a $1 million at retirement. Here are just a few.
- Home equity line. If you own a home, apply for a home equity line of credit. If approved, you will get you a checkbook from which you can write checks if you have an emergency.
- 401(k) loan. Check with your employer to see if your 401(k) allows for loans. You can withdraw 50 percent of your balance up to a maximum of $50,000, or if your 401(k) balance is $10,000 or less, you can borrow the full amount.
- Credit cards. This is often the quickest way to access cash or pay for an emergency –- often even faster and more convenient than withdrawing cash from a traditional emergency reserve account.
- Investment account. As long as you don't have illiquid investments, the $75,000 you invest can be accessed within a day or two at most.
A Few Thousand in Cash Is OK
Instead, make sure you have access to assets if there is an emergency. Maybe set aside a few thousand in cash, but take the rest you would have set aside and invest it. Over time –- and in this case, 35 years –- there is a good chance you'll do a lot better than if it just sat in your checking account.
If you get laid off or are anticipating needing the funds, sell some or all of your investments so you can sit on cash and not have to worry about investment performance while you are withdrawing money from the account. Once you get a job and things stabilize, re-invest the cash back into a diversified portfolio.
When we are all trying to improve our lives a little bit more in retirement, we need all the help we can get. An extra $1 million would sure be a good start.
Robert Pagliarini is a best-selling author and Mission Viejo financial planner who focuses on sudden wealth recipients. Connect with him on Twitter at @rpagliarini.