Picture Credit: David Merkel / Aleph Blog || I call the middle of the graph “the slope of hope,” but really, it depends what side of the graph you are on…

This is one of my basic pieces on personal finance. The shape of the graph is illustrative, and the units don’t mean anything. It’s meant to motivate a simple concept that everyone should maintain at least a minimum savings buffer.

It is as Solomon said in Ecclesiastes 9:11:

I returned?and saw under the sun that?
The race?is?not to the swift,
Nor the battle to the strong,
Nor bread to the wise,
Nor riches to men of understanding,
Nor favor to men of skill;
But time and?chance happen to them all.

https://www.biblegateway.com/passage/?search=Ecclesiastes+9%3A11&version=NKJV

Accidents happen, both bad and good. We also will grow old, and get weaker. We may meet untimely deaths. Alternatively, we may live a comparatively long period of time, and find we didn’t lay enough aside for our old age.

Even the best of us may not plan well enough for the contingencies of life. That said, there is adequate preparation for most emergencies. First comes a buffer fund of 3-6 months expenses. Second comes basic insurance coverage: health, property and liability. Third comes insurance coverages for others that need your support: life and perhaps disability insurance. Fourth and last is planning for long term goals like retirement and perhaps some help for kids going to college.

This article is meant to deal with the first of those preparations — the buffer fund. It is meant to show how difficult life can be when you don’t have it, and how not having it likely means you may never have it. On the other hand, if you have the minimum buffer fund you may find that bit-by-bit, you get better off.

There are two reasons for this: first, both saving and not saving are usually habitual. This correlates partly with income, but more with your degree of future orientation. I’ve known managing directors on Wall Street that were living paycheck to paycheck. I’ve also known immigrants that earn little, but save half of it. Are you willing to sacrifice some of the present to gain a better future? Are you willing to consume the future through borrowing for expenses in order to have a temporarily better time in the present?

This is one reason why people with the buffer fund tend to keep going upward — they keep saving and investing. And, many without a buffer fund always find themselves in debt. Stuck in debt.

Then there is the second reason: accidents. Those with the buffer fund can handle most bad accidents, and can take advantage of most good accidents. We can call the good accidents “opportunities.”

When the person with the buffer fund faces a bad accident, it is typically a “speed bump.” Nothing notable happens to family life. If no bad accidents happen, he may find that he possess valuable options for the use of excess cash:

1) Pay your insurance premiums in annual installments?
2) Buy your next car without financing it?
3) Pay off your credit card bills in full each month?
4) Ask for a discount for cash when buying big ticket items?? (You?d be surprised.? I drove quite a deal with my orthodontist for my wife and eight kids. I?m the only one that hasn?t had braces.)
5) End the escrow account on your mortgage?
6) Pay tuition bills in full, rather than a payment plan?
7) Take advantage of financial crises, and extend credit at tough times?? (I am still receiving 13% from a business associate that I lent money to in March of 2009, with warrants.)
8 ) Retain cash in your corporation to reduce financing costs?
9) Not worry about the minor disaster that recently hit?
10) Raise your deductibles on your Auto, Home and Health insurance premiums to save money?
11) Receive discounts on services that you want to receive, by getting a discount for buying years ahead?
12) Fund your 401(k), IRA, HSA, whatever, to the fullest?
13 And more?

http://alephblog.com/2011/09/01/build-the-buffer/

When others are offering great deals in the rare times where they need fast cash, the man with the buffer fund (and more) can take advantage of the situation and become even better off.

He can also take advantage of the flexibility that has has to start a business, or, work for a startup that he thinks is particularly promising.

For those without a buffer, at best it can be treading water. But an accident can force someone underwater. Most of the avenues for borrowing with those not having assets who are borrowing to meet expenses are expensive in terms of the rate paid, and onerous in terms of the terms demanded.

Once enslaved to onerous debts, it becomes very difficult to get out of the slimy pit. Note also that credit scores affect all manner of economic affairs, and can affect insurance pricing (wealthier people are better risks on average), job applications, rental opportunities, and much, much more… consider this a minor third reason why my graph above applies. Penalties from banks and credit card companies are stiff, and further entrench debts.

And to those that are really bad off, driving uninsured, not keeping up with payments to the motor vehicles department of your state, not paying on auto debts can find their car repossessed, with the possible loss of employment if he can’t get there. At worst the person can lose the ability to rent and be out on the street. These thing don’t happen overnight, but I have seen them happen piece by piece. It is desperately difficult to reboot a life once you no longer have a place to live. Predators hire people like that, and find ways to cheat them. Those with no assets and many debts have no means of defense. In some cases friends and family may help, but even they cut their losses when things seem hopeless.

This is pretty glum stuff. Aleph Blog is first realistic, and second optimistic. Bad things like these happen, and the people who hit the bottom are typically not only poor money-wise, they are poor relationally as well. Typically they have offended most family members and friends on the way down, and are simply surviving in shelters and tent cities, maybe working, maybe begging, maybe stealing. It’s tough, and for those that work with them, it is exceedingly tough to rebuild the habits and conditions that modestly successful people have.

Closing

So is this just “The rich get richer, and the poor get poorer?” No, it is only partly that. For those that are starting out, make it you goal to be a saver and have a buffer fund of at least three months expenses. For those that are in debt and trouble, fight as if your back is against the wall, and pay off the debts. As you succeed, maybe some friends and family will see the change in your life and help you. For those that are working, but hopelessly behind on debt, declare bankruptcy with the firm determination that you will find a way to make it different in the next phase of your life.

Those at the very bottom need personal help to reboot their lives. Government programs won’t do it. Some churches and focused charities succeed slightly at it. It all depends on whether habits will change or not, and that is the toughest nut of all, humanly speaking. I have seen it happen. I have seen it fail. It comes down to the willingness to sacrifice to create a better life later, which is where this article began. Will you give up some of the present to get a better future? That is where the rubber meets the road.

PS — David X. Martin’s book Risk and the Smart Investor is an engaging way to deal with this topic for those that are better off.