Moore for your Money
BYRON MOORE, CFP®
Question: I’ve got about three month’s living expenses in a bank account. It kills me to have all that money in a place that pays me exactly zero interest. Is there a problem with putting this money in a mutual fund?
Answer: Yes, that would be a problem in my view.
Any mutual fund that would earn more than a bank account is going to be invested in securities that can fluctuate significantly in the short term. If you have to use the funds in this account for an emergency, and the account is down 20% or 30%, you now have two emergencies.
Here’s what I want you to consider: put more money in your boring bank account, ignore the interest rate they pay and see this account for the wonderful wealth building opportunity is can be.
Having three months’ worth of living expenses in a bank account is much better than having nothing. But I’d love to see your account equal six months of your annual income. I’ll tell you why in moment.
This is going to take a serious commitment on your part. If you were starting from scratch and saving 10% per year, it would take you five years. If you save 15% (my typical recommendation), you’ll reach this goal in about three years.
And, yes, I want you to keep all that money in a boring, low interest rate, guaranteed, predictable and available bank account. The important thing here isn’t the interest rate earned, but the availability of the funds in the event of an emergency or opportunity.
I call this your emergency and opportunity account, or “E&O account” for short. And I want you to treat your E&O account like a bank.
The E&O account is simply a traditional bank account from which you can “borrow” to spend on big ticket items you would normally have to finance with debt. This may include automobiles, major appliances, vacations, etc.
You are not actually borrowing anything – you are withdrawing your own money. Yet you want to treat the withdrawal as a loan, and pay it back…with interest. You can use an online calculator to figure the payment due each month over an appropriate period of time. Set up a repayment schedule, just like you would if you had a car note or a loan repayment to a bank.
This strategy of “borrowing” from and repaying yourself is the perfect way to keep your spending and capital replenishment in balance.
For example, Jessie has $50,000 in his E&O account. He decides he wants to “borrow” $35,000 to buy a new car. So he asks his banker friend how much the bank would charge for a car loan and his friend tells him 5%. Jessie finds an online calculator that tells him the monthly payment on a $35,000 loan repaid over 60 months at 5% interest would be $658 per month.
Jessie sets up an automatic payment from his checking account to his E&O account for $658 per month for 60 months. After 60 months, Jessie has $54,480 (assuming his bank pays him 0% interest). If Jessie had borrowed from a real bank and repaid the $658 per month to them, his own bank would have had to pay him $4,480 in interest over the same 60 months for things to be equal. And that’s unlikely to happen.
Multiply this example by all the automobiles, large appliances, vacations and other big ticket items you may typically finance with debt, and you could keep a lot of money in your pocket you might otherwise pay to someone else.
The key with the E&O account is the use the same cash flow you would normally send to a financial institution in debt repayments to simply replenish your own capital after you spend it.
If you cheat yourself on this point, you’ll be the one to pay the price.