Uncertainty = Real Life: It’s Different Out There Now
This chapter is a real kick in the pants. I’m still hugging you, but I’m also hoping to give you a hard dose of reality so that you can survive modern financial life without worrying.
With the rise of precarious employment, stagnating wages, corporate cutbacks and robots that could take over your job, there’s no denying that a lot has changed over the past 10 years. Without a financial plan that reflects this new economic reality, you can find yourself wide awake in the middle of the night, worrying about what you’ll do if you get laid off or the furnace breaks down or interest rates rise. If you’re not financially prepared to roll with the punches, you’re going to be constantly living in scarcity mode, which breeds more and more frequent F*ck-It Moments.
With this new reality in mind, I began testing a theory with clients that I’m now convinced is an important antidote to worrying about money. You might want to write this down: Have an emergency account. Revolutionary, right?
Defeating the Scarcity Mindset Once and for All
Having an emergency account is one of the most common financial tips out there, but more often than not it’s dead last on my clients’ lists of financial goals. That’s why I want to take a moment to stress the importance of emergency savings, especially in these “interesting” times.
I know there are plenty of reasons to avoid emergency savings. Paying down debt feels good because you’re getting it off your plate and saving the interest. Saving for a home, school, business, renovations or a wedding also feels good, because you’re saving up for something big, tangible, financially responsible. Add in the pressure from banks, financial experts and family telling you to make your money “work for you” and warning you that you shouldn’t have money “sitting around doing nothing,” and it’s no wonder emergency accounts get no love. Well, I love, love, love emergency accounts.
An emergency account is not a waste of resources. Think of your emergency account like having parents at a high school party. You resent them when the party is going well, but if party-crashers show up, you realize very quickly how grateful you are that they’re there to contain the damage.
Here’s what I’ve been noticing over the past five years: clients who have money stashed in their emergency accounts feel broke less often than those who don’t, and they don’t overspend as much either. Maybe you’re thinking, Well, duh. Of course my clients with emergency accounts don’t overspend. They’re obviously good with money. But for many of them, it wasn’t always so.
Emergency Accounts: A Warm Blanket of Calm
For years Daryl suffered from yo-yo budgeting and general money anxiety. During that time, whenever he came in for a financial checkup, my advice was always the same: “Prioritize emergency savings. Keep the money in a high-interest savings account. Do not touch it unless it’s an emergency.”
He always agreed at the time and then months later would admit that he had taken all his emergency savings and thrown the money at the mortgage, or into his retirement account on the last day of the year, or at a trip on a whim. All very reactive financial decisions.
“I know, I know,” he would say to me. “But the Bank of Canada announced that they might raise interest rates, so I panicked and threw it on the mortgage. Then, during tax season, the bank kept reminding me to invest, so I threw some into my retirement account.” While these may not sound like bad financial decisions on the surface, the problem was that none had been made with purpose or planning. They were knee-jerk reactions, driven by outside pressure and by his own fears about the future. He was worried all the time and losing sleep, even though his long-term savings were on track.
“I just don’t see why I’d keep money in a savings account when my investments are getting 6 percent and my savings account is getting 1 percent,” he finally confessed to me. “Plus I have my line of credit for emergencies.”
I understood his thinking. Looking only at the math, the argument definitely favours investing the money or paying down the mortgage over keeping that money on the sidelines in a high-interest savings account. But over the years I’ve seen the positive psychological effects of having an emergency account. There’s something very powerful about opening up your banking app or statement and seeing a big chunk of money sitting there. It’s like a warm blanket of money calm.
Loads of people want to use their line of credit as their emergency account. But here’s the thing: you still need to pay it back over time. If you use your line of credit for an emergency, you’re going into debt to bail yourself out of a financial emergency situation. This compounds your fear and anxiety that you’re not going to be okay. Borrowing to dig yourself out of financial emergencies only makes you feel more out of control. You didn’t have enough money to bail yourself out, so now you’re making your financial situation worse to solve the problem. It’s like kicking yourself while you’re already financially down.
But with an emergency account in place, you won’t be left with a financial hangover when things get back to normal. You’ll feel more in control over what’s happening because you were prepared. This will make it easier to stick to your plan over the long haul.
But still Daryl could not resist the siren song of “make your money work for you.” When he came back to see me again, he was two months into an unexpected job loss and his situation had worsened. “You never think a layoff is going to happen to you until it does,” he said.
With no emergency account to get him through the layoff, he had racked up $8,000 in additional debt on his line of credit just to survive, leaving him feeling defeated, frustrated and broke. That was the tipping point for him. He understood at last that even though leaving money in a lower-interest emergency account might irritate him sometimes, it was more important to have it within reach when he needed it. So once he found a new job, he made it a priority to rebuild his emergency savings account and keep it for emergencies, regardless of the investment returns he could potentially earn or the interest he could save on the mortgage.
In Daryl’s case we needed to put aside money for unexpected repairs and job loss. He had great private health insurance, so he felt covered on that front. Here is how his plan looked:
Daryl’s monthly Fixed Expenses totalled $3,000, and he figured he needed $1,400 per month to pay for groceries and gas so he and his son could get by if he lost his job again. That came to $4,400 per month after tax ($3,000 for Fixed Expenses + $1,400 for basic spending).
Daryl received $800 per month in child support from his ex. Because Daryl was an employee, in the event of another job loss he would likely qualify for approximately $2,000 per month in Employment Insurance benefits. That would give him $2,800 per month ($800 + $2,000), but he needed $4,400 per month just to get by. Without an emergency account, he would be short $1,600 ($4,400 – $2,800) each month.
Daryl had already seen what would happen if he had to turn to his line of credit for this money, and he never wanted to be in that situation again. He was ready to set aside enough to fund three months’ worth of basic living expenses. In his case, that meant $4,800 ($1,600 × 3). Based on his historical spending patterns, his emergency savings would need to also include $3,000 for average annual home repairs, $1,600 for car repairs and the $4,800 for unforeseen job loss, for a total of $9,400. If he took two years to rebuild his emergency account to $9,400, he would need to deposit $391 per month to that account for 24 months ($9,400/24).
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A year later, Daryl and I checked in again. His emergency fund was at $10,000 (he had received an unexpected tax refund), he had stopped fretting about the money “doing nothing” and he was sleeping much better.
“How’s it going?” I asked.
“Good. It’s funny, before I had the emergency savings account on the sidelines, things used to really freak me out. If I had a bad day at work or my boss was acting weird, I’d internalize that and worry about it for days, convinced I was going to lose my job. I realized I was terrified of being fired or let go because I didn’t have a safety net, and the littlest thing in the office could send me into a tizzy.” Now that he had an established emergency savings account in place, he didn’t lie awake at night analyzing something his boss had said and worrying about layoffs that he couldn’t control.
“I’ve survived one layoff and now I know I’m prepared if it happens again. And I’m not scared of my house anymore. I used to see it as a money pit and was really resentful every time I had to drive to Home Depot or hire a contractor to fix something. I knew that was part of home ownership and that stuff was going to happen, so it never should have felt like a surprise. But because I wasn’t financially ready, it always did. Now a water mark on the ceiling doesn’t feel like the end of the world. I know I’ve got money set aside to deal with it.”
This has been the outcome for so many of my clients. Fears and anxieties about money can be reduced by having an emergency account that you can see every time you log into your online banking. There is something innately satisfying about seeing your safety cushion. It’s reassuring on a deep level. “Sometimes,” Daryl admitted, “when I’m starting to feel anxious at work or anxious about the house, I open up my online banking app and just look at the emergency account. It honestly makes me feel better.”
Believe me when I say that your money is working for you in an emergency account. Not in a hit-you-on-the-head-with-financial-returns way, but on a deeper, emotional level. Always attack high-interest debt (like credit cards) first and then put in the effort to build your emergency fund over time. Make it a priority. It’s as important as your other savings goals. It’s the key to Worry-Free Money in these interesting times.
The Unknown Future of Work
Robots are real and technology is advancing faster than ever before, touching every aspect of our lives. Who doesn’t like advances in medical technology that can save lives or an app that can have your coffee ready for pickup every day at the time and place you like? But on the buzz-kill side of things, the uncertainty of future work is a reality. Experts are predicting more short-term temporary jobs and more major shifts to come.
The future of work is uncertain, and many of my clients are worried about whether they will have a job in 15 years. I share their fear—the words robo financial planner can cause a sleepless night for me. Sure I tell myself that I embrace technology and that I’ll find a way to adapt my business and continue to add value, but I can’t always get that kind of perspective. That’s because I don’t know what adapting will look like or if it will work in the future. It’s scary.
I’m not writing a manifesto on how technological advancement is going to throw us into a post-work economy, but not addressing the robotic elephant in the room will not make it go away. Counting on the financial assumptions that we planners used in the past is unrealistic and even naive. The new economic landscape likely means fewer jobs and lower wages on the horizon. Financial advice given even five years ago doesn’t hold water in the face of this new reality. We need to adjust our ideas of what being okay financially means, so we can thrive.
Kirsten and Jocelyn Ages: 34 and 46 Relationship status: married Kids: 2, ages 2 and 5 Annual gross household income: $115,000 ($55,000 + $60,000) Assets: house valued at $385,000; $55,000 in retirement savings (Jocelyn has a defined-benefit pension plan) Liabilities: $200,000 mortgage at 2.5% interest |
Kirsten lived in a townhouse with her partner and their two kids. “We’ve outgrown the house,” she told me at our first meeting. “We’d like to sell it and get a bigger place but I’m afraid to.”
Kirsten and her partner had a combined household income of $115,000 ($7,000 per month after taxes and deductions), which was great. Jocelyn worked an administrative job. She wasn’t sure what the future of academia looked like and was worried that her job might not exist in 15 years. “I will probably lose my job to a robot,” she said.
Kirsten and Jocelyn’s goal was to purchase a bigger home in the same town. Their friends, family and communities were all there, giving them the advantage of free daycare four days a week (score!). They wanted a $650,000 house and had been pre-approved for the $465,000 mortgage they would need. But could they afford it in light of a changing workforce?
“We want to ensure that we’ll be okay if neither of us has a solid income or a job 15 years from now,” Kristen said when we sat down.
As much as I hated to validate her worry about the future of work, given the stark realities of modern life, I agreed with her. To ensure that they would be okay, we needed to come up with a plan that would meet the following goals:
• Be mortgage-free in 15 years.
• Save 12 percent of Kirsten’s gross income for retirement, in addition to Jocelyn’s defined-benefit pension ($550 per month).
• Travel for $7,200 every three years ($7,200/36 months = $200 per month to Short-Term Savings).
• Put aside $3,600 per year for home repairs and emergencies ($3,600/12 months = $300 per month).
• Maintain a similar amount of Spending Money ($2,500 per month) so they wouldn’t feel broke in order to make the plan sustainable.
It’s important to note that we were diversifying their risk between real estate and stock market investments, not choosing one or the other, to prepare for retirement. If you have decided that renting versus owning is best for you, be sure to take advantage of the fact that you don’t have to worry about paying for repairs and maintenance or interest on a big mortgage, and put that extra money away! You’re not building equity on something you could potentially sell one day, so you should be aiming to over-save towards your retirement. Aim to save 20 percent of your gross income if you’re renting, which is double the minimum 10 percent savings rule-of-thumb.
On the next page, you’ll find a snapshot of the couple’s finances before we figured out how big a mortgage they could realistically afford.
In order to meet these other goals and maintain their spending level, Kirsten and Jocelyn needed to keep their mortgage payment to $1,765 or less in order to still be able to afford all their other Fixed Expenses ($1,685), Meaningful Savings ($550), Short-Term Savings ($500) and Spending Money ($2,500). Using the online mortgage calculator, we found that a $265,000 mortgage at 2.5 percent with a five-year term would result in payments of $1,765 per month if it was to be paid off over 15 years.
Monthly after-tax income |
$7,000 |
FIXED EXPENSES: Money You Cannot Spend |
|
Mortgage |
? |
Utilities and condo fees |
$245 |
Home insurance |
$90 |
Property tax |
$300 |
Cable/Internet |
$100 |
Phone |
$200 |
Car insurance |
$150 |
Part-time daycare |
$600 |
Total |
$1,685 |
MEANINGFUL SAVINGS: Money You Cannot Spend |
|
Retirement savings |
$550 |
Total |
$550 |
SHORT-TERM SAVINGS: Money You Cannot Spend |
|
Vacations ($2,400/year) |
$200 |
Emergency fund ($3,600/year) |
$300 |
Total |
$500 |
SPENDING MONEY: Hard Limit |
$2,500 |
Our plan—with a $265,000 mortgage—didn’t look much like the one they had been approved for, with good reason. On paper they could afford a $465,000 mortgage amortized over 30 years, assuming that low interest rates lasted forever. But when we took real life into consideration, we realized they couldn’t rely on that assumption going forward. A mortgage of $265,000 was what they could truly afford if they wanted to stick to their plan without worrying about their financial future.
If the approximate equity in their current home was $185,000, they could afford a house costing approximately $450,000 ($265,000 mortgage + $185,000 down payment), assuming that closing costs, realtor fees and so forth were dealt with outside this equation. This was $200,000 less ($650,000 – $450,000) than the house they wanted to be able to afford. A sacrifice to be sure, but here’s the thing: saddling themselves with a $465,000 mortgage that wouldn’t be paid off for 30 years would put Kirsten and Jocelyn in deep trouble if they had to take a pay cut or lost their jobs altogether in the next 15 years. Plus, overextending themselves would just lead to sleepless nights.
Kirsten and Jocelyn left with a plan that wasn’t exactly what they wanted, but it felt good and safe and freed them from worry. They wouldn’t be overstretching themselves and could deal with the uncertainty of the future. They were willing to make those sacrifices in the short run because the fear of being jobless and feeling scared every time they spent money was worse than the disappointment of living in a smaller place without a backyard big enough to implement the plans they had been daydreaming about. This was a direct opt-out of the expectations on their Life Checklist.
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I know the whole uncertainty-of-work thing is hard to hear, but I believe it’s naive to ignore it. For anyone out there who is worried about whether they will be okay financially in the future, making changes now is critical. I like to call it “robot-proofing your life.”
• Always attack high-interest debt (like credit cards) first, and then put in the effort to build your emergency fund over time. Keep the emergency money in a safe, liquid account that you can easily access, and don’t get tempted to spend it on a vacation. Make it a priority.
• Don’t overextend yourself. If you have a mortgage or you’re thinking about buying a home with a mortgage, try to match your amortization period with a realistic time horizon for stable and steady income. Could be 15 years, could be 25 years, but ensure that you’ve thought about this and what is realistic for your industry.
• Diversify your long-term savings. Ensure that you’re putting aside money to pay down your mortgage as well as investing in your retirement portfolio. If you’re renting, aim to save 20 percent of your gross income for retirement.
• Ensure that you’re saving enough for retirement and the future of uncertain work. Given that the job market may change drastically for all of us in 10 or 20 years, if you know that you’ve got a plan of attack, you can stop being afraid, because you know there is enough money in the long run.
Robot-proofing is like a Boy Scout motto for financial planning: Hope for the best, prepare for the worst. And if the worst never happens? You’ll be debt-free sooner, with money to spend. Win-win all around!