Borrowing vs. Saving for Contingencies
In spite of how much we rely on credit, we also need to consider accounting for these things up front more, saving up for them before they happen, especially if we do not have credit to fall back on, but even if we do.
The ability to borrow to look to balance out spending spikes is what really separates contingency saving from long-term retirement savings, because this borrowing will always be relatively short-term and also require that we have the capacity to pay back the debt. We can’t do this in retirement because retirement means an income shortfall and you can’t make up for that with borrowing, which requires an income surplus not a shortfall.
When we borrow for things, we have the benefit of not needing to account for the expenses now, as well as not running the risk that we will deprive ourselves too much to save for something that never happens.
It can certainly be tempting to not worry about such things until they happen and then deal with them as they come up, and this isn’t a terrible strategy provided that we can adjust things well enough to accommodate the extra monthly payments that this borrowing will require as it is needed.
Where people get in trouble here is that they make financial commitments that do not allow for this additional capacity to be used, because it does not exist. We need two components in place here, the means to borrow and the means to repay what we borrow.
If we don’t have both of these, then using credit for contingencies simply isn’t going to work. If we can’t borrow enough and we do not have enough savings either, we’re simply going to have to do without, and some of these expenses are not so optional.
If your roof leaks and it needs to be repaired, or if your car breaks down and it’s not under warranty, these are very important things that we need to fix, and if we don’t have the money, we are in real trouble. In this case, the need for contingency savings is going to be higher or much higher than with those who do have a plan to handle such things fairly painlessly.
If we do have enough borrowing capacity to handle these events, there’s also the matter of being able to pay the money back. Given that we haven’t saved for these things, we probably don’t have the capacity to pay back loans or revolving debt without making some real adjustments, but these adjustments may not be able to be made depending on the circumstances.
In some situations, we may not be able to adjust our spending down enough to allow for us to make payments on what we borrow for contingencies, and this is often caused by having too much debt already. The first step to look to set this right is to cut down on the amount of these debts, or to refinance them, but refinancing can be dangerous if we don’t break the cycle of overspending, and often we do not.
By taking discretionary borrowing and amortizing it over the life of our mortgage, we do end up lowering the monthly costs of servicing the debt, and this can appear to be a very good thing at the time, but only if we change our ways and look to extract ourselves from this problem rather than using it as a means to overdo things even more.
People get in trouble financially because they spend more than they should, and this limit does not just involve having enough money to make ends meet, as we also need to account for the ability to set aside enough for the future, whether that future is decades away or next month if something comes up that is not a normal expense.
We can use credit three ways, to buy something we cannot afford now, to buy things we can never afford, and to be able to buy thing later that we need that we will not be able to afford then but can over time.
Whether or not we should buy something now or wait until we’ve saved for it is going to depend on how much we want or need it, and whether we can really afford it later, whether we can afford both the cost of the item and the interest costs of borrowing.
If we can’t afford it either now or later, then it should be pretty obvious what we should do, although not so much with some people. The desire to spend can be a powerful one indeed and we may simply buy and not think about such things much or at all, especially if the expense is seen as needed.
In some cases, these expenses are very much needed, but this still may not be a situation that we want to be in, to actually need to borrow and if the borrowing itself is unwise and unsustainable. If we do find ourselves in this unfortunate circumstance, we may need to make some drastic changes to our spending to fit this in, or this may lead to insolvency.
It All Really Comes Down to Spending Levels
We often speak of saving, and the need to save, without really thinking enough about what saving actually means. Saving money is purely a function of spending less money than we make. Given this, saving is all about spending less.
We are told that we should have a good-sized contingency fund, half a year’s salary for instance, and this is sound advice indeed. People may be aware of the need but simply do not have the commitment to put it into practice, because their desire to save becomes surpassed to a large degree by their desire to spend.
There are some people who just don’t have the means to save very much, because their income is so low that they may just be able to get by on it and maintain a pretty minimal standard of living. For many of us though, we could save quite a bit if we really wanted to, but we just don’t choose to.
In order to accomplish this, or at least make an honest attempt to do so, this may require a real paradigm shift, where our attitudes about what we really need to spend requires a complete re-assessment.
To do this, we do need to prioritize our savings, and although this only really requires us to understand more properly how important saving money is, many people are reluctant to various degrees to put the weight on saving money that it deserves.
People will therefore cling to ideas that some forms of what are actually highly discretionary spending isn’t so discretionary, and that they deserve to live the lifestyles they do even though this does eat up almost all of our income and we end up saving too little or even nothing at all.
The things that contingency saving saves up for, provided that they are valid things to spend on, are also of this category. When these expenses arise, we don’t generally think that this is not something we need, because the problem is that we do need them but just don’t have the money for them.
This isn’t so much a matter of the importance we place on these future purchases, as when we don’t have the money for these things, this is simply a matter of poor planning. Many of us don’t really plan our personal finances that well, even though this should not be all that difficult.
It is not that we haven’t been taught these things in school, or have any sort of formal education about personal finance, because this is more a matter of common sense than anything. Things will come up, we will either have the money to handle them or not, and it’s just better to have the money than not have it.
This also includes planning to have enough available credit should we need to borrow, and borrowing capacity does certainly have its place, even though we ideally should be seeking to use our own resources for these things.
If something will cost $100 a month over 2 years, and it may come up, we need to make sure that we can pay this $100 a month or we’re simply not going to be able to handle it at all. This means that we have to be in a position where we can afford this, and if we can afford it then, generally we can also afford it now.
If we set this $100 aside now, then we’re using the capacity that we need now, and can earn money in interest on it, and especially can save interest when the need arises and we buy it from our own money rather than borrowing over these 2 years.
Saving for contingencies can therefore be seen as a more responsible way to execute something that we will need to do or at the very least be in a position to do. If we’re in a position to do it, it is more responsible to put the plan into place now, do it now, rather than shirk this and worry about it later.
Most of us could do much better at this, but this won’t happen unless we understand how important this all is and dedicate ourselves to plan our lives better.