Consumer debt is bad! Get yourself out of debt as quickly as possible! Having any kind of outstanding money against your name is the worst thing ever.
This is the common message as far as personal finance advice goes. Stay out of debt, and you’re well on the way to being a responsible financial person.
Whilst I do agree with all of the statements, high-interest consumer debt is pretty crappy. Borrowing money to buy something, then paying back more than you took is a fantastic business model if you’re the one doing the lending. Not so much if you’re the borrower.
One of the most common types of debts people get into is credit card debt. You get sucked in with a nice introductory offer. Then you go crazy with the massive amount of ‘money’ you now have available. Before you know it you’re maxed out, your introductory period is over and you’re paying back so much more than you borrowed.
A scenario I think we have all had exposure to in some capacity.
But can credit card debt be a good thing? Could a credit card even make you richer…? Let’s find out.
The argument for good debt.
There is no such thing as good debt, however, there can be such a thing as helpful debt or potential debt. Make no sense? Let me clarify.
A mortgage, in my book, is a helpful debt. This may irk some people, but not many people would ever be able to afford to purchase their own home without a mortgage. Student loans, in some specific cases, can also be seen as good debt (I’m looking at you doctors and architects).
A 0% credit card, can be a fantastic potential debt if used correctly. I like to think of potential debt a bit like my incredibly urgent emergency fund.
I currently have a 0% interest credit card which is roughly 30% ‘full’. This gives me a full £2,100 of bandwidth. There are not many things that could happen in my life that £2,100 wouldn’t solve. Car repairs, vet bills or house repairs would mostly be covered with that amount of money.
How does that help? It means my emergency fund can be working for me. Most personal finance bloggers/thought leaders advocate having an emergency fund. Normally 3-6 months expenses. Setting money aside for rainy days is incredibly sensible, but having that sat in a shitty 1% interest savings account is a pretty poor investment.
The alternative? Keep your emergency fund invested and have a credit card for any true emergencies. Realistically, there are not many emergencies that would require you to have vast sums of money available instantly. The 3-5 days it would take to pull money out from an investment would be enough to cover any situation. If you can think of a situation, please do let me know because I’ve been wracking my brains writing this post and can’t think of a single one.
An invested emergency fund, what if it loses money?
Great question actually, as we all know investments can be volatile. Equities especially. However, it is also commonly known that bonds are much less volatile than equities. Welcome to the world of asset allocation.
My ‘normal’ portfolio is in a 90/10 equity to bond split. This is considered risky but given my age I have enough years ahead of me to work through all the peaks and troughs. My invested emergency fund works with a different split: 60/40 to be precise.
This is much less risk-averse, 60/40 is commonly seen as the asset allocation you would move towards once you start drawing down your investments.
The benefits to this? Well, my emergency fund that could be sat earning a measly 1% interest rate in a savings account now has all the potential returns of the stock markets. 7%? 10%? 15%? The sky is the limit.
But how would this work in a real-life scenario when disaster strikes? Let’s say our roof springs a leak and we have a £1,500 bill to repair it. Let’s say that the £1,500 needs to be paid instantly before the builders will start work on the roof. A very unlikely scenario, but a potential scenario all the same.
I’d use my 0% interest credit card, heck this doesn’t even need to be 0%. I’d use any old credit card to pay the builders, job done. At the same time, I’d start the process for selling and withdrawing the equivalent amount from my invested emergency fund. As soon as that is sat in my account my credit card is paid off. No interest accrued, no stress and a pretty foolproof process. I’d then begin the process of sending back in the exact amount I withdrew over a period of months.
You are the weakest link
There is one obvious and pretty fundamental flaw to this approach. You! Humans just don’t have very good self-control. The shiny new credit card with a £3,000 limit. Well, that could just buy you a new games console, a new wardrobe or whatever other things it was that you wouldn’t normally be able to afford. That is the danger with this approach, but with a small amount of discipline, you can have more money in the market than you ordinarily would. As the saying goes:
Time in the market is better than timing the market
Keeping the money sat in cash ‘just in case’ gives me the exact same chills that paying for insurance does. You’re paying cover for something that you hope never happens. If you go through even just a few years of your life with no ’emergencies’ your 6 months of cash could have been earning 10% (the average return over the last century).
To put that into numbers, if your monthly expenses totalled £1,500 that would mean a £9,000 emergency fund. Earning a 10% a year return over 4 years your £9,000 would have become £13,176.90. That’s £4,176.90 of extra cash. That is a rather lot of money.
The optimum approach
This strategy is not for everybody. Some people I know would not feel comfortable having any cash buffer in their lives. That, I do appreciate and can completely agree with. I have a pretty high-risk tolerance so am quite comfortable living this way.
All this said I do still believe in a having a small amount of cash. Totalling around £1,000. This allows me to cover any small over-spends without me needing to sell down assets. Anything above and beyond that, it’s in the market.
That, I believe, is the optimum approach. 1 month of absolutely core expenses in easy access cash savings, the rest in a reasonable liquid investment that could be withdrawn if required.
Can you really afford to not work this way? How do you manage your asset allocation?