Comments on: Pay Debt or Build Emergency Fund?

By: Augustine

Augustine — Sun, 08 Nov 2009 18:20:46 +0000

However, emergencies occur all the time, such as new tires, a car problem, a sick pet, etc. I don’t think that it’s realistic to discuss this subject as if someone actually goes a year without any emergency. And in the case that nothing was saved, they’ll only compound the credit card debt and increase the minimum payment, keeping the debtor in the debt treadmill by making it harder for him to save.

Finally, the emergency fund can also accrue interest.

By: JOE

JOE — Sun, 08 Nov 2009 00:44:16 +0000

Yes, only if the ‘emergency’ actually occurs. For every month there’s no issue, that savings adds up.

By: Augustine

Augustine — Sat, 07 Nov 2009 22:56:17 +0000

Joe,

If one does end up having an unforeseen expense and charges it because one didn’t save for a rainy day, wouldn’t it end up costing the same as foregoing extra payments in order to save? After all, the new balance will require higher service costs any way.

By: Michael Harr @ Wealth...Uncomplicated

Michael Harr @ Wealth...Uncomplicated — Sat, 07 Nov 2009 00:47:22 +0000

@Joe – think of it like this. The $1,000 is an education expense in the sense that you are paying a little extra interest annually to establish a habit that will return many, many times the interest expense. If you don’t have the $1,000 and just go back to a credit card, you’ve done nothing to change the habit of relying on credit cards.

Another point of clarification on the $1,000 as it relates to Dave Ramsey. Before you set aside the baby emergency fund, a plastectomy has already occurred. The simple act of cutting up the plastic and making a vow to never go there again is backed by the $1,000 because if you limit your resources, you will naturally be more resourceful.

To support this last point, I offer up the fact that many seniors live on a fixed income. They know what their resources are and they must manage them as best they can to ensure they don’t end up homeless. While we all know that the average retirement nest egg is horribly small, these fixed income retirees make it work.

The same is true for those trying to get out of debt. The best way to get out of a hole is to stop digging (plastectomy), throw away the shovel (never use it again), and start the new habit of climbing (even if it’s at a snail’s pace) out of the hole.

It’s all behavior and almost no math…the same could be said of personal finance in general.

By: JOE

JOE — Fri, 06 Nov 2009 22:52:03 +0000

I’m still having mixed thoughts on this. That $1000 is costing you year after year of interest until the emergency happens or the cards are paid off.

By: Bucksome Boomer

Bucksome Boomer — Fri, 06 Nov 2009 19:04:05 +0000

I believe in having a small emergency fund while paying down debt. Yes, you could put an emergency cost on plastic, but might end up paying interest on it before getting it paid off.

It’s better to have the small emergency fund of $500 or $1000 and not have to worry about adding more debt if the water heater goes out.

By: Adam@RabbitFunds

Adam@RabbitFunds — Fri, 06 Nov 2009 17:31:11 +0000

This is an excellent question and one that I have posed to myself a number of times. I have a small amount of debt that I’m trying to finish paying off but I also maintain the $1000 emergency fund that Dave recommends. When I first heard Dave talk about saving $1000 before paying off debt I also thought, “Well that doesn’t make mathematical sense.” However, as @Michael points out, it makes a ton of behavioral sense. It helps build discipline. But more importantly, it helps avoid additional debt. For example, if I have $1000 in the bank and my car breaks down, then I have cash reserves to pay to fix it and I don’t have to charge it on the very credit card I’m trying to pay off.

So although the math says pay off debt first, behavior and life happening suggests that a small emergency fund makes a lot of sense.

By: Michael Harr @ Wealth...Uncomplicated

Michael Harr @ Wealth...Uncomplicated — Fri, 06 Nov 2009 04:52:20 +0000

This is always an interesting question. If you’re a math guy or gal, you’ll opt to skip the emergency fund because the math tells you you’re going to save money and get out of debt faster. If you’re an experienced pragmatist, you’ll opt to keep the $1,000 or more for emergencies.

What Ramsey advocates has everything to do with behavior and nothing to do with mathematics. In a post I wrote awhile back, I posited that those following his teachings were far more likely to get out of debt and be successful in the future because of the behavioral shift that his methods create. Escaping the calculator and dealing with the ‘person-al’ part of personal finance is the key.

Nice topic…always a good question.

On a related note, remember when Suze Orman shifted her position on this? In the end, there are many schools of thought, if you subscribe to any of them and execute, you’ll be fine.

By: Augustine

Augustine — Thu, 05 Nov 2009 20:47:33 +0000

I’d say that the problem with both approaches is that they’re posed as either one or the other. However, I see no problem with applying both one and the other.

By: Monica O'Brien

Monica O'Brien — Thu, 05 Nov 2009 18:38:30 +0000

Interesting post and question. I think it makes more sense to pay down your debts. An emergency fund of $1000 is some serious insurance on the idea that something “might” come up. Why not pay $1000 down and IF something happens, then the worse thing you do is put that $1000 back on your credit card?

Like John, I pay off my credit cards every month in full. I’m not a fan of having credit card debt – did that once and it was one of the most miserable periods of my life. Now that the debt is gone I will do whatever it takes to stay out of that position, even if it means forgoing an emergency fund when money is tight.