When an emergency occurs, you can be sure you will need cash. i.e. illness, accident, leaky home, problematical employer, redundancy, difficult business partners, impossible work colleagues, economic downturn, poor prices, too much competition, modern technology outdating you, drought, flood, or even worse, a death in your family.
But picture this………….
You have done well to get debt down from $500,000 to $200,000 over 10 years and then you hit a crisis.
You ask your bank manager to lend you $100,000 to tide you over. He refuses saying “we can’t lend to you when your financial affairs are shaky.”
You reply somewhat desperately “but I have been so good at repaying debt, look at my record.”
“Sorry” says your bank manager, “your financials don’t look too good. We can’t help you.”
You have managed your affairs well and reduced debt down from $500,000 to $300,000 over 10 years. At the same time, you have stashed away $100,000.
You hit a crisis, but with your $100,000 stash, you are able to cope till things get better.
You don’t even need to talk to your bank manager.
But shouldn’t we pay off our mortgage as fast as possible?
In theory yes, but emergency money is just so important, and especially so in this uncertain world. How awful it would be to lose everything by not having stashed away $50,000 to $100,000 (not a lot these days).
You invest it in a low risk fund that is likely to earn about the same as your mortgage costs you. Therefore, it will be cost neutral, or close to, but even if you are out of pocket by a couple of thousand a year, it is essential.
Remember though, never invest it anywhere near your bank.
Stress and the black dog
Every crisis is stressful, but cash can help a lot in making it manageable. And when stress is manageable, so too will be your ability to keep making good decisions.
You will probably find that you are able to beat the black dog – depression – too.
So when the sun is shining – when things are good - don’t get too elated, don’t plough it all back into your farm or business - build up your liquid assets too.
I realise many a new business or farm was built on heavy borrowings when they started out, so new businesses or farms often don’t or can’t do this.
But mature businesses and farms nearly always can.
By all means reward yourself too, but ………………….
If your big reward might cost $100,000, look at what $50,000 might buy, and put the other $50,000 into your emergency fund.
Am I being too cautious or too gloomy?
Samuel Eaqub is an independent economist and consultant. Here are some of his recent comments (abridged).
NZ banks have perpetuated the bull run in Auckland house prices and dairy conversions, by lending too freely. The risk for NZ is bank stress - if they get fearful, they will be reticent to lend so the system stalls, and as we know, “banks like to lend money when the sun is shining, but want it back when it starts to rain.”
Kiwis gorging on debt
He says we are vulnerable in NZ because we have not learnt from the 2009 GFC. We have gorged on debt through the last few years to buy houses from each other at ever higher prices, and loads of dairy conversions too.
Gravity cannot be defied
Prices will always recall the laws of gravity in the end. And if the banks get too edgy, or even panic, they will pull back lending to the real economy – the lending that creates real businesses and jobs.
The Reserve Bank of NZ says their modelling shows the banks have sufficient capital buffers, but he says their modelling is mistaken. Indeed, he is urging them to take action to stop the banks aiding and abetting debt gorging, and creating economic vulnerability.
Is Mr Eaqub right?
I’ll leave it you you to decide if he makes sense or not. But either way, we should all have a cash stash.
Do it while the sun is shining
Build up your liquid assets while the sun is shining, so when it rains you have control over your own affairs, and can cope.
Supplied by Alan Clarke, financial & retirement adviser, & author.
His 2nd book “The Great NZ Work, Money & Retirement Puzzle” is available on line.
Alan is an independent authorised financial adviser (AFA) FSP26532.
His disclosure statement is available on request and free of charge.