Nov. 11, 2005 at 11:00 AM ET
How far are you away from financial ruin? Probably not more than a few weeks.
A new survey conducted by the financial services giant HSBC suggests that four in 10 Americans don't have even one month's worth of living expenses saved up in case of an emergency. Should crisis hit -- a hurricane, a lost job, a sudden relocation -- people in this category simply have no "Plan B."
That flies in the face of advice that personal finance experts have given for years. So, if you're in that spot, here's some practical advice.
In its survey, HSBC asked if a catastrophe like Hurricane Katrina hit, how many months of basic living expsense did consumers have saved up. Over 60 percent of respondents said they had less than three months savings.
"That caught us by complete surprise," said Carlo Airdo, director of credit education for HSBC North America. "That's very concerning." The firm launched a Web site named www.yourmoneycounts.com to coincide with the survey.
Earlier this year, the Commerce Department announced that the personal savings rate among Americans had dipped below zero. In other words, the average person now spends more than they make each year. Economists are debating the significance and accuracy of the data, chiefly because it doesn’t include the extra money people have gained in home equity or other investments. But they are missing the point.
Americans clearly are not prepared for a disaster -- natural or economic. A disturbing amount of people are living paycheck-to-paycheck. For evidence, just look to the Gulf Coast. Hurricane victims were so desperate so quickly, in part, because they had no buffer. Many had no way to make mortgage payments, pay credit card bills, or deal with other debts when their incomes were suddenly interrupted.
What if it was me?
If you were lucky enough to watch the Rita, Katrina, and Wilma hurricane disasters on TV -- instead of watching them up close and personal -- you couldn't help but wonder, what if that was me?
Perhaps you were even motivated to buy and stash a supply of water, non-perishable food, even gasoline. But what's the most basic essential of all in a capitalist economy: money? The worst red tape of all is the red tape you’ll find when you simply cannot support yourself.
Personal finance experts recommend keeping about three months worth of living expenses in a special account, hidden away for a rainy day that hopefully never comes. But about half the country is simply ignoring that advice.
Here’s one reason why: Saving three months worth of living expenses would require consumers to chart three months worth of expenses. Staring the monthly budget in the face is often an ugly process, a bit like looking in the mirror the morning after a night of heavy drinking. For many, it seems better not to look. That might work for a while; that is, until the day a natural disaster strikes, or the pink slip arrives. Then, all the poor planning comes home to roost.
The price of angst
Last month, I wrote about FEMA suspending its $2,000 expedited assistance grants for hurricane victims, and thousands of people wrote to MSNBC.com complaining that they had been unfairly denied FEMA assistance. Their stories were tragic, but underscored the problem -- an alarming amount of victims had absolutely no margin for error in their lives. A few weeks of bureaucratic delays in FEMA aid left them destitute. With no savings, they had no flexibility, and were completely at the mercy of a bureaucracy that failed them.
But even before disaster strikes there's a cost to the lack of a Plan B: financial anxiety. The HSBC study found that 80 percent of Americans say they are worried about their level of savings. How can you put a price tag on angst?
Dollars just don't add up
How did so many Americans get so close to the edge? Things are different in Europe. According to a research letter published by the Federal Reserve Bank of San Francisco, personal savings rates in Germany, France, and the U.K. all hover over 10 percent. Europeans don't have the same love affair with credit that Americans have. And, they haven't been drugged quite as much by the wealth effect of housing boom. In the U.S., a startling amount of people -- 50 percent -- don't pay fully pay off their credit card bills every month. Since many are paying usurious interest rates, one has to assume they don't have a lot of cash saved up. Otherwise, those folks would avoid the high interest rates and pay down the debt.
But I'm not suggesting grabby consumerism is the only cause. Ask anyone you meet at any bus stop in America -- the squeeze is on. Healthcare costs keep exploding, gas prices are high, this winter's heating costs are looming large. College tuition is about the price of a decent three-bedroom house in a second-tier U.S. city. To paraphrase Harvard's Elizabeth Warren, author of The Two Income Trap, an average American working at an average job just can't afford an average home any more. The dollars just don't add up. So we squeeze the difference out of credit.
Don't look for relief of this state of affairs from America's credit industry. In fact, emboldened by the new bankruptcy law, which makes it harder to escape debt, credit card firms have increased the minimum monthly payments required on many accounts. In many cases, they’ve jumped from 2 to 4 percent, doubling that line item on debtors' montlly budgets.
Open – but don’t use – a line of credit
"Obviously, a lot of families are on the edge, living paycheck to paycheck," says Liz Pulliam Weston, author of Your Credit Score and several other personal finance books. "There is big group that is incredibly vulnerable, not just to a disaster, but also to life's everyday ups and downs."
If you're one of the 40 percent of Americans who couldn't make it through next month without a paycheck, Weston has some firm advice. But it's not what you might think. Don't simply start squirreling money away, she says.
"There are still more important financial goals," she said. Paying down credit card debt still takes top priority in her book. That also gives you a step in the right direction towards financial crisis readiness, because you'll be freeing up your available credit. Funding disasters with credit cards is not optimal, but it’s better than the alternative.
Weston also advocates a step many might not consider -- opening up a personal line of credit with your bank *before* you need it. That way, you will get the loan on your terms. You'll lock in a good rate, and have the time to shop around.
The trick is to leave the account empty -- don't be tempted to use it to pay down credit card debt, because you're likely to keep up your current spending habits and land a big credit card bill again.
Instead, use the line of credit as your get-out-of-jail-free money, your financial lifeline and plan B. That'll buy you some time to build up savings of your own.
Home equity is not a disaster plan
As for that negative personal savings rate, optimistic economists like to point out that the statistics don't include appreciation on investments -- basically, many people enjoy increased equity in their homes. American consumers, the theory goes, are saving money simply by owning a home, which continues to rise in value 10 to 20 percent each year. Home equity itself is savings – both rainy day savings and retirement savings.
I could start down the road of the housing bubble debate at this point -- there is one, and if you are counting on home equity to retire on, you are gambling -- but I won't. That argument is immaterial in this discussion. As any smart investor will tell you, you never want to be in a position where you don't get to pick the timing to cash out an investment. If disaster strikes and you have to sell or take out a home equity loan, you may very well be forced into unfavorable, costly terms. Just ask someone trying to sell a house in Washington D.C. at the moment, where buyers have suddenly gotten shy.
And, more to the point, ask someone who might try to take out a home equity loan now on a house in Cameron Parish, where the hurricane hit.
Who knows what might happen to house prices long-term? But everyone knows rainy days do come. We are all vulnerable to something -- a hurricane, a tornado, an illness, or downsizing. The sad truth, we now know, is that we cannot count on our government to come to the rescue. That makes now a good time to get your emergency kit ready, and stocked full of food, water, gasoline, and, most importantly, MONEY.