Last week a friend of mine told me that he was inheriting $50,000 from a relative who passed away. He was all excited about what he could buy with $50,000. Visions of buying a 5-series BWM or adding an addition on to his house danced in the air. When he asked me what he should buy, I couldn't help becoming the stick in the mud.
The horror!! I asked if he considered saving the money. Oh ya, that made me real popular!!
At first he thought I was being a real jerk. But, then I started asking him about his financial stresses.
While he and his wife make a lot of money, the number one tension in their marriage is money. It turns out like most of us, he has no emergency fund. Despite making a high 5-figure salary, all of it would go in and then out every month with not much left over for savings.
I suggested that a $50,000 emergency fund might change his life in ways that he never even thought of. With $50,000 in saving he and his wife would not have to worry about losing their house if one of them lost their job. Never again would they sweat tax season. He would not have to worry about the financial impact of life's little emergencies.
This is financial freedom. Most people define financial freedom as having enough money to retire and live off of their savings. But, I think that this might be too narrow of a definition. People can achieve financial freedom much earlier in life by creating an emergency fund large enough that most financial worries disappear.
An emergency fund can change your outlook on life by taking away a lot of life's financial stresses. Sure you will still need to save for retirement, stay debt free, and continue to spend less than you make, but creating a fully funded emergency fund is one of the best ways to change your life.
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{ 7 comments… read them below or add one }
If $50 is the right emergency fund, I’m ok with the advice. But – Do they have any credit card debt? Nothing like freeing up $400-$500/mo in payments you don’t need to make.
Do they fund their 401(k)s to the max? Over the next few years they can turn this $50K into maybe $75K in their pre-tax account (depending on their bracket and market return.)
How about slipping $10K/yr into a Roth? Invested in CDs, treasuries, it can be tapped for emergency, but can grow tax free, and as their income grows, and non-retirement real emergency account is built up, can be flipped to ‘real investments.’
How much is left on their mortgage? Throwing a chunk of money at your mortgage can turn into a many-year savings at the back end. Nothing like cutting 10 years off the back of your mortgage with one check.
Just a few thoughts. None include a car like that. Funny, you can hand me $1M, and the car is something that wouldn’t even cross my mind.
Joe,
I agree a lot with your analysis of his options. I know that my friend does not have any debt except for his home mortgage loan. While I am not sure if he maxes out his 401k contributions, I do know that he contributes enough money to take advantage of his employer’s 401k match.
Given that information, I still think that having a fully funded emergency fund is the way to go. I am not saying that he should not invest this money as long as it is invested in liquid, risk-free investments.
I love investing emergency fund money in a mix of high interest savings accounts and certificates of deposits. While his interest will not be great, having the peace of mind of an emergency fund is great.
Then, he needs to max his 401k contributions, fund his children’s college funds and pay off his mortgage. Then, it is time to retire!!
Hawk,
If this was 2 years ago this could have been me you were talking about. I usually get a yearly bonus and around the same time some company stock awards vest, and I was always looking for the next toy to add to the arsenal or improvement on the home. I’m 100% with you on the emergency fund especially considering they are out of debt except for the house. Hope to be “that guy” in the coming year myself. Good for you for speaking up too even when it’s not popular.
Good call. I think it’s a good idea to set a time frame before you make a purchase with that money.
I’d say give it 6 months or so to think about what you’d like to do with it and assess where the needs are. That way you avoid some of the impulse reactions.
Also, it’s not a bad idea to carve out some of the money and go buy something you really want. Say you take like 10% of it and go splurge and then use the rest for emergencies or paying off debt. That way you can “enjoy” it too.
Jason,
You bring up a good point about taking a portion and doing something fun with it. I think that treating yourself to something pleasurable, but still less expensive is a way to reward yourself for saving more.
I don’t think a $50k emergency fund is probably necessary. I know if it was me and I would pay down my mortgage/second mortgage. I know the power of what I could accomplish without a mortgage payment is far greater than the comfort I would get from having $50k laying around.
We hired a Financial Advisor over ten years ago, who did a financial analysis of our income, assets, expenses, etc. His advice was excellent and today we are financially secure. We have no credit debt, except our home.
What many people do not take into consideration is: What happens if the husband dies? If these people who inherited $50K have children, how does the standard of living change for the wife?
If the wife passes away, how much will it take for the husband to hire someone to come in and care for the children, if they are underage and not in school? Even if they are in school, who is there when the children return home from school? There are so many variables to consider. If the husband or wife become medically unable to work, what then? One must know how much they would need to live, if they experienced the above circumstances. How many years will your savings keep you solvent. I don’t know if they are self employed but if they are not, then there is a possibility that they can lose their jobs.
One never know what will happen to us. Your life could change in a nanosecond.
It the husband and wife who inherited the 50K, have good jobs but all the money they earn goes right out for bills, then maybe they should take a closer look at their expenses and how to cut costs, so that they can save from their salaries.
There are so many people who are losing their homes, who NEVER expected anything like that to happen to them.
Money is power. It gives you the power of peace of mind, if an emergency arises.