The Investor: More than One Way to Fill a Financial Gap
This is one of those columns – like the one in which I confessed that I don't have a goal for my retirement savings – that might make the 'conventional wisdom' people cross. But here goes: We don’t all need a sizable emergency fund sitting in a savings account.
14 July 2012
What prompted this is a survey by Visa that includes in its findings, "More than half the citizens in New Zealand, the UAE, Australia, Canada and the United States cannot financially survive a personal economic emergency lasting more than three months."
© 2022 Mary Holm, NZCity
This was based on responses to the question: "How many months worth of savings do you have set aside for an emergency?"
I suspect many respondents thought only about bank savings. They probably didn't include all the other ways a New Zealander might finance their way through a loss of income for several months. Some that spring to mind:
• Adding to a mortgage. This is especially easy if you have a revolving credit mortgage, but can be done with other types of mortgages too.
• Claiming on income protection insurance.
• Making withdrawals from a KiwiSaver account because of significant financial hardship.
• Getting a low-or-no-interest loan from a family member. Okay, this may not be great if you don't have the capacity to repay it fairly promptly. But Kiwi family members – and sometimes also friends - do help one another out.
• Going on the dole. You’ve probably paid taxes for years, and it might be your turn to ask the government for help for a while.
I haven't included the one solution some people will resort to - running up long-term credit card debt – because it's not really a solution. Compounding interest on credit cards is a killer.
But many New Zealanders who don't have much of a bank savings accounts would still manage through several months without income.
I'm not trying to discourage rainy day savings. Of course it's good to have some money that you can access in an emergency. But it doesn't have to be thousands of dollars languishing in an account earning a few per cent interest - and even less after tax.
If none of the above options would work for you, you might want to use a combination of "laddered" term deposits and a credit card.
Let's say you want to set aside $8,000, and that your bank offers 3-month, 4-month, 5-month and 6-month term deposits – as most banks do.
Start by putting a quarter of your money - $2,000 in this case – into a 3-month term deposit, $2,000 into a 4-month deposit, $2,000 into a 5-month deposit and $2,000 into a 6-month deposit.
Then, as each deposit matures, reinvest it in a 4-month deposit.
Your first $2,000 will therefore be available to you after three months and then seven months and then 11 months and so on. Your second $2,000 will be available after four months and then eight months and then 12 months and so on. For the third, it will be five, nine and 13 months. And for the fourth it will be six, ten and 14 months – and on into the next year.
In other words, at any time you'll have $2,000 maturing in 1 to 31 days, and another $2,000 in 32 to 62 days. You can then put expenses on your credit card, knowing that the term deposits will be maturing to cover the credit card bill.
Laddering enables you to receive what are usually higher interest rates for longer-term deposits, but also to have money available quickly when needed.