It is during times of crisis and panic that people finally realize the importance of an emergency fund. I know it’s not sexy or cool to have a bunch of cash sitting around…especially when others say that that cash could be working for you. But I’ve met a lot of people over the years who live far too tightly month to month than I would have the stomach to do. And it’s an unfortunate sad truth that even before COVID-19, most Americans were already only one paycheck away from a personal financial crisis. Now we find ourselves in the middle of a pandemic that is bringing the world economy to its knees as we try to protect the health of the world’s population, which could test even the most prepared of us.
For some, it may be too late to finally get around to building up that emergency fund. But for others that are still collecting a paycheck, I encourage you – as I have encouraged those who work for me – to save as much as you can over the next few months. This means cutting out all nonessential spending. None of us know how long this will last or how long the paychecks will keep coming. We are only a few weeks into this and we have only seen the beginning of the hard decisions that so many companies are going to have to make. I can tell you from working in Finance for my entire career that companies are currently scenario-planning and coming up with expense cuts to be made. You need to know that they are reviewing their entire list of employees and ranking them from essential to nonessential. I don’t write this to scare you but instead to inform you.
The government will step in to try and soften the blow but there is only so much it can do. No government measures can possibly save every single job. And government definitely cannot stave off all of the pain undoubtedly ahead as a result of these very challenging times we find ourselves in.
I wrote a post almost three years ago titled “Can These Good Times Last Forever? What Happens If The Music Stops?” and for the first time since the Great Financial Crisis I think we can all agree that the music has in fact stopped. I knew then that at some point, some unknown event would come rock all of our worlds. I think everyone intuitively knew this. All you have to do is look back on history and see that it’s never been sustained rainbows and butterflies. I have always believed that you can’t have the sweet without the bitter. Just like you can’t have life without death. It is the contrast inherent in this fact that makes life so precious.
Before we move on, I would like to share the opening of that post I linked above as a reminder of the choice we have in both times of euphoria and gloom.
Most people who know me well would likely describe me as a super optimist and that’s the way I prefer to live life. The alternative is to be a Negative Nancy, draining the energy of self and everyone else around.
I tend to believe that OPTIMISM actually CREATES ENERGY, EXCITEMENT, and PASSION. I would go as far as to say that optimism is the path to happiness and fulfillment in life.
On the flip-side of the coin, PESSIMISM is the ULTIMATE DESTROYER of all the good things in this life. Therefore, pessimism is the path to depression and disappointment.
What path would YOU rather be on? The key thing to realize is that the CHOICE is yours to make.
If you choose the former (to be an optimist like I do) over the latter, it doesn’t mean you won’t have your pessimistic moments. We all need to be a little pessimistic at times. It’s important to acknowledge from time to time, that the world is not all rainbows and butterflies.
There are bad things that happen in the world.
There is risk.
And no one is immune to inevitable bad luck.
That said, as an optimist, this pessimistic thinking should only consume 1% of your energy at most. You should acknowledge the downside, prepare with a contingency plan, and then move back to building your wildest dreams.
I don’t know about you, but these were words I needed to re-read. I plan to refer back to this over the coming weeks and months as we work through these very challenging times. I have never been one to be a fear monger but I have always acknowledged and prepared as best I can for the eventual unknown risks that lie ahead. It took me years to finally put words to my approach but these days I refer to it as my “risk mitigation first” approach to personal finance.
Accessing Your Minimum Monthly Spend (MMS)
I was already stress-testing our own finances back three years ago when I wrote the post that the above excerpt was pulled from. Since then we have only taken additional steps to de-risk and build a solid financial foundation. And now that we find ourselves in the eye of the storm with tons of uncertainty I think it’s a great time to revisit what our minimum monthly spend is today – three years later (I encourage you to do go through the same exercise). Unfortunately, I made the decision to stop tracking our spending starting in 2020, but that’s okay because I still have all the details in our Personal Capital account. I also have our history from the previous five years of spending of which I think 2019 is most relevant.
We have purposely been setting up our financial life for ultimate optionality and flexibility. And therefore our fixed expenses are very minimal compared to most households. But before we dive into that analysis, I would like to share one additional excerpt from that post I wrote three years ago:
Frankly, the current euphoria in the market has me cautiously optimistic, as my gut tells me we are in for a potential Frozen Twinkie situation. You may be wondering what a Frozen Twinkie situation is, so let me explain.
It’s when someone hands you what appears to be a regular, chemically engineered, and delicious fake food known as a Twinkie. You bite into it with excitement and joy, only to find out that it was completely frozen in the middle, causing you to chip your tooth.
Because I get the feeling that the good times may have a speed bump in the near future, in addition to addressing everything above I also felt compelled to look at our spending from a minimum monthly perspective. I actually had this conversation with my wife and accidentally freaked her out a bit, but I explained to her that I wanted us to be prepared with a contingency plan to cut way back in the event of a major blow to our current standard of living.
Historical Expenses As a Starting Point
Note: We no longer have a mortgage as we paid that off in May of 2019. I had always added back the amortizations since these were really just a balance sheet transfer. Going forward we no longer have any amortizations to add back. The adjusted spending is the real expense base I will be starting from.
As I look at the above, it is very obvious that lifestyle inflation has certainly crept in, and that was by design. The law of 50/50 that has guided our financial lives since 2015 provided for a free pass to lifestyle inflation. That said, we’ve tried to be careful and not lock ourselves into an expensive lifestyle by committing to lots of fixed costs. Therefore we worked to make our spending as variable as we could. As you look at the above, you will notice in red font that I’ve added the previously excluded insurance premium costs for benefits like health, dental, and vision. This was intentional on my P&L in years past as I treated them like a tax, something you had to pay off the top, because now it’s the law!
The cost of our premiums plus contributions to an HSA account to pay for our deductibles and out of pocket expenses had been pretty flat from 2015 through 2018. We then had our first child in late 2018, which caused a significant increase in these costs. And, now in 2020, I run my own business and pay 100% of those costs. The annual premiums to cover the GYFG household are $13,316 and that is for a high deductible plan that has a max out of pocket for the family (if in-network) of an additional $16,300 (it’s double that if out of network). This is certainly an expense I want to make sure I pick up in my analysis in calculating our MMS.
Although I’ve only provided the high-level categories, I do have the detailed expenses that roll up into each major bucket in the above, which is much more helpful in conducting this sort of analysis. Since we are using 2019 as our base year, we are cutting from our most gluttonous spending year on record. My goal for this first pass was to accomplish two things:
(1) Better understand where we are spending money.
(2) Then identify enough “fat” to cut in order to get our annual spending below $100,000 per year.
Yes, I did say “first pass,” because if this thing goes on longer than a couple of months, we will go back to the chopping block and keep adjusting our lifestyle and expenses as needed. I witnessed far too many people during the last financial downturn not cut deep enough or fast enough, which led to compounding pain for them and their families.
After reviewing our expenses (and cutting many as I went through this review by canceling memberships and subscriptions) we landed at an MMS of $8,068 or $96,814 annually (see expenses listed below).
This represents a cut of $111,888 vs. our 2019 spending of $208,702 (a 53.6% cut). In addition to that, we have also identified the additional expenses that we could/would cut if things get really bad in the next couple of months (or reduce like the insurances I highlighted).
If you add all of the expenses in red, they total $38,191 annually. This would bring our MMS down to $4,885.25 or $58,623 annually. This would only happen if things get really bad, as in my wife and I both lose 100% of our income. This is a level of spending that we could sustain for years without any income and drawing from the liquid portion of our net worth (CASH).
This preparation may be overkill but it is going to help me sleep at night. I would rather be quick to act and have that action be unnecessary than to continue as if everything will go back to how it was as soon as these restrictions related to the COVID-19 pandemic are lifted. This is not me trying to scare you, it’s me leading by example, and I hope you will undertake a similar exercise and put your own contingency plan in place.
I’ve now spent my 1% on pessimistic thinking. I’m prepared for whatever comes my way and will now return this channel to our regular programming as seen through my optimistic lens. Although I can’t predict how painfully or for how long our lives will be disrupted, but I can say with full confidence that we (the world) have decades of prosperity and happiness ahead of us. We will emerge from this more resilient than ever. This crisis will ultimately lead to more innovation and unintended insights that will propel us toward a brighter tomorrow.
Onward & Upward!
– Gen Y Finance Guy
7 Responses
Thanks for this, good advice as always.
“…for the first time since the Great Financial Crisis I think we can all agree that the music has in fact stopped”
>Not only has it stopped, there’s a danger that the speakers have been so badly damaged in the stoppage that we wonder when they’ll be able to play music in the same way again. Governments around the world are in a race against time to figure this conundrum out. At least in the current crisis, unlike 2008, Central Banks have been scanning the horizon for dangers to their economies and have come out fighting (and fast) using every tool at their disposal.
‘…we’ve tried to be careful and not lock ourselves into an expensive lifestyle by committing to lots of fixed costs”
> This is a really good strategy. I’ve always thought of this as ‘quick-release lifestyle’, the expenses you could cut in a jiffy if required. Of course, this will only be possible if one’s basic needs are already covered (a hypothetical person spending 100% of their available resources to cover only the essentials of food, water and shelter would have no expenses which they were able to ‘release’ because all of their spending is necessary for their survival).
“This is a level of spending that we could sustain for years without any income and drawing from the liquid portion of our net worth (CASH).”
> Nice work! A 53.6% reduction in spending with an option for an additional 47.6% reduction in a ‘doomsday’ scenario. For the cash is it held in actual cash or is it in money market instruments or something similar? I’ve taken to splitting my cash across a number of financial institutions to remain within government deposit guarantee limits and provide diversification across financial institutions in case any of them were ever to ‘gate’ withdrawal of deposits or, even worse, subject them to a haircut (as happened in Cyprus in 2013).
“I would rather be quick to act and have that action be unnecessary…”
>My thoughts exactly, the only preparation one truly regrets is the preparation which would have been helpful but was not put in place when there was ample time to do so. I think in virtually all cases it doesn’t hurt to be ‘over-prepared’ in fact.
Stay safe and batton down the hatches, it’s going to be a rough ride!
HH
HH,
I’m glad you found the post useful. We are actually holding cash in multiple financial institutions. As well as some in our safe.
We have deployed a significant amount of cash this month between stocks and real estate (more to come in the March financial report). However, we are holding back a at least three years of expenses at a spending amount between the spending levels I outlined in the post.
We will be re-evaluating every couple of weeks for the foreseeable future.
Dom
It’s going to be very interesting to see how the FIRE community reacts to the market downturn and possible impending recession. Far too many bloggers were overly aggressive in their investing and lifestyle planning. People were holding far too little cash and were expecting to be able to retire while spending 4% of their net worth.
Like you, we’ve been building a sizable cash reserve for the last 3-4 years. As a result, we are actually excited that the market has finally dropped and we can finally deploy some of this cash.
I’m in the midst of doing the same expense analysis that you’ve been doing. We aren’t quite at the point where we can live on our dividends and rental income, but between that and our cash I think we could survive for at least 5 years with no additional income. If we cut our expenses we could last even longer.
It will be interesting to see what content is like from the FIRE community over the next 6-12 months.
We have put a good chunk of cash to work between 3/12 and 3/23 – most of it from my rollover 401K that had about $172,000 (that’s now in my IRA). We had some other funds in another IRA for my wife that was sitting in cash that we put to work. All said, we put about $200,000 to work in an 11 day period.
We have earmarked another $385,000 for a real estate deal (details to come in April). This leaves us with about $250,000 in cash after we deploy the $385,000.
It does make me nervous deploying the $385,000 but I like the deal long term. It makes me want to cut back to the more aggressive spending level in the short term until I see the sales pipeline come back to life in my business. My wife and I will be reviewing this plan over the weekend and again every couple of weeks.
It’s hard to fight the fear that comes with uncertainty. Future deployments of capital will only happen from cashflow from the business, dividend/interest income, or when other investments I have mature like life settlements and/or hard money loans (combined is about $320,000).