Matt Likes Analysis, I want to ask you about your thoughts on emergency savings. Previously, you’ve basically argued that holding cash is a huge tax on long term wealth and people should rely on credit. I couldn’t find the original thread we discussed the topic.
You have definitely made me question conventional wisdom on this issue. But the one thing I cannot grasp is why this is a good strategy, since the access to credit changes if you become unemployed. Could you explain why this is not an issue?
They won’t find out you lost your job until after the fact. Like I will prolly leverage with a home equity loan, plus my car loan on the event I lose my job. I also know of a spot that will lend you 25k at 5.5 percent rate without any collateral. Ish amazing
i was thinking about it also. i think MLA mentioned it again recently in the investment section.
it makes sense if you have home equity that you can tap. otherwise you would have to sell some of your investments which would lead to a loss of compounding. and most likely you are selling at the bottom if you get laid off during a recession
my auto loan is 0.99%. Almost done with payments too, so that’s an extra g of spending money per month. I will most likely reliever my auto loan as soon as I finish payments at 2.5% at my credit union.
haha well fair enough. I just remember I bought a house when I switched jobs. All they wanted was my last 2 pay stubs which was from my last job. So I figured a person can easily take a loan out even without a job.
Yes, technically using the phrase auto loan implies collateral behind the loan. But Lightstream uses it based on use of proceeds, not collateral. PNC has also started a check advance product to buy cars, but IIRC it becomes secured after the purchase is made.
This is from the Lightstream email. They really emphasize it (its in bold at the very bottom):
Important Reminder: Do NOT have LightStream listed as a lienholder on your vehicle title or loss payee on your insurance policy. If your lender or insurance company inquires, just tell them that you did NOT use secured financing. This will save each of us paperwork hassles in the future. Thanks!
Yes, technically using the phrase auto loan implies collateral behind the loan. But Lightstream uses it based on use of proceeds, not collateral. PNC has also started a check advance product to buy cars, but IIRC it becomes secured after the purchase is made.
This is from the Lightstream email. They really emphasize it (its in bold at the very bottom):
Important Reminder: Do NOT have LightStream listed as a lienholder on your vehicle title or loss payee on your insurance policy. If your lender or insurance company inquires, just tell them that you did NOT use secured financing. This will save each of us paperwork hassles in the future. Thanks!
they don’t know if you lost your job unless you apply for new credit. you’re obviously not going to apply for new credit with no income. you don’t need to “re-prove” your income before drawing on a line of credit that is already established.
if you can establish a HELOC at a low rate (prime-ish) for several times your salary, that is all you would ever need for emergency capital.
an unsecured LOC can usually get you where you need to be. if you live in a major city and have a white collar job, you should not be unemployed for very long, even in recession, and the odds of you being fired during recession is actually quite low.
the basic idea is that if your emergency fund were invested as a 60/40 mix and achieve a ~7% long-term annual return and have a drawdown of 20% max, that’s going to beat the pants off of temporarily drawing on a 5% unsecured LOC or a 3% HELOC.
say your emergency fund is $50,000 and you go 10 years with no unemployment, and you make 7% on your “emergency fund”, you’re looking at $90,000 after tax versus $53,000 after tax if you were invested in a 1% yielding MM fund. even if you were unemployed for two years in those ten, the interest cost would only be $10,000 if using an unsecured LOC and assuming full draw over those two years. you’d be way ahead even if you saw the 20% drawdown at the end of that period and had to draw the funds.
in canada, the need for an emergency fund is lesser as you get $26,000 in unemployment benefits over a year after being laid off and you get additional benefit increases if you have kids. i would get another $14,000 based on the number of kids i have. in canada, the math points towards maintaining credit entirely. in the us, if you have an unstable job, maybe an emergency fund could be useful, but if you have an unstable job, you probably can’t get an unsecured LOC anyway. basically if you can get an unsecured LOC, that’s the bank telling you to not have an emergency fund.
What are the odds that an actual emergency could cause you to lose your HELOC? This may be low probability, but read your contract, know your LTVs and consider what the worst case scenario is.
This may be obvious, but if the emergency is due to you becoming unemployed then you have to pay back the HELOC. Where does that money come from? Presumably future wages, which would otherwise be available to invest.
Personally, I don’t rely on a HELOC typically for an emergency fund. For me, it makes more sense to have a few months of cash around to bridge the gaps. Where a HELOC can be good is if I need liquidity for an opportunity but have cash tied up somewhere else. Anyway, this thread did make me reevaluate my LOCs and shop around a bit. I haven’t done that in a while.
On a related note (and CvM would heartily agree with me), pay down debt even if your ER > the interest rate on said debt. It’s better from a cash flow perspective and you’ll be in better shape should you fall on hard times. Yes, I know it goes against everything we’ve learned, but sometimes you have to take a more pragmatic approach when it comes to your money.
odds of losing your heloc are low but it is besides the point.
if you invest your emergency fund in a 60/40 portfolio and rely on credit in emergencies, you can still tap your emergency fund if you’ve exhausted your credit. bank calls in the heloc, you sell your investments and cover. the 60/40 portfolio shouldn’t be down much more than 20% from peak valuation at any given time. not maintaining open credit facilities and banking on just your emergency savings means you will likely have less than half of what you could otherwise have available. far too many people have emergency savings in cash and no open credit lines. it’s the opposite of what you should be doing and it means that you’ll have less emergency capital when the need arises. and if the need doesn’t arise, you could have millions more to show for astute capital allocation, depending on your lifespan.
^see the funny thing is 10 year bonds yield 2%, to me thats essentially cash. lol. fv is 1.2189
i am willing to bet that market timing and holding cash is quite preferable cuz i imagine we’ll have a 20% decline and a bounce back within 10 years. so thats a 25% upside minimum.
haha well fair enough. I just remember I bought a house when I switched jobs. All they wanted was my last 2 pay stubs which was from my last job. So I figured a person can easily take a loan out even without a job.