As I’ve mentioned approximately 3,920 times (we’ll have to double check that, but I’m 99% sure it’s right), us here at Financial Uproar (me and 63 cats) aren’t big fans of the emergency fund, at least the way it’s presented in the personal finance world.
There’s nothing wrong with saving, say, $1,000 in cash. Stuff happens, and it’s smart to keep a few extra bucks kicking around to deal with it when the time comes. And as I’ve mentioned before, just about everybody has insurance to cover them for any expenses more than $1,000.
It’s the rules of thumb beyond that I have a problem with. It’s downright silly for somebody with any amount of debt at all to be sitting on multiple thousands of dollars of cash when they’re paying interest. Even if somebody is debt free, that money needs to be in investments, not making 2% sitting in some banker’s pockets. Stuff like that is the difference between the wealthy and the middle class.
Personal finance rules treat every person the same even though they might have wildly different jobs. A teacher isn’t getting fired unless they expose themselves to little Timmy, while the average freelancer is as secure as a 14-year old’s bike. These two people should not have equal emergency funds.
Having thousands of dollars kicking around for an emergency that might never come is a huge opportunity cost for someone just starting out, especially if that person can put that money to work in active investments. Even getting a 2% dividend on an ETF is a whole lot better than getting the same interest rate from a bank, because that ETF investment has a very real chance of growing.
What if there was a different way for people just starting out their personal finance journey? There is. Here’s why layoff insurance could be a good idea.
What’s layoff insurance?
Traditionally, layoff insurance is something that banks have pushed on their clients. It’s usually called payment protection insurance or something like that.
In theory, it’s pretty straightforward. You pay a premium each month, and if you get laid off, the insurance starts making your payments for you. For the most part, this is limited to your mortgage, although there are plans that will cover credit cards and other debts.
The issue is in the small print. In the UK, a form of layoff insurance led to one of the largest financial scandals to ever hit the country. Banks pushed payment protection insurance to millions of customers, and then didn’t pay out when these people lost their jobs because of certain conditions in the fine print. Authorities in the country are still sorting out the mess, giving consumers the right to complain about their PPI policies. At this point, nobody really knows when is the PPI deadline.
Most Canadian policies only cover folks who have a regular job, so business owners can’t try to claim it. You gotta be a full-time employee or close to it, and it won’t pay out if you get laid off less than 90 days after you start the policy.
The cost isn’t too bad, coming in at about $15 for every $100,000 in mortgage principal. And there are a number of conditions surrounding getting laid off as well. You can’t quit, or be fired with cause, or get voluntarily laid off. It covers people who legitimately lose their job under no fault of their own.
How anyone can use this
Let’s run a hypothetical situation. You take out a $300,000 mortgage, which costs you $1,500 per month. Say in total you’re spending $5,000 per month for everything in total. According to personal finance rules of thumb, you gotta have $30,000 kicking around in an emergency fund.
With layoff insurance, you can very comfortably stick to a $1,000 emergency fund, provided you’re consistently investing outside of your mortgage. If you get laid off severance will likely be enough to cover your expenses until EI kicks in, and layoff insurance can cover the mortgage. Chances are, you’ll never even have to liquidate any of your investments.
This wouldn’t be permanent. If your mortgage is so large you can’t get ahead, then you have no business getting the loan in the first place. Layoff insurance is most interesting when if covers a period of time between getting a mortgage and getting your investments back up to a respectable number. It’s a buffer for folks who clear out a big chunk of their savings for a down payment. You pay the $45 per month for a year or two, save some cash, and then punt the policy when you’ve got a decent investment account built back up.
Ideally, everybody would be swimming in cash when they go to buy a house. They’d put 20% down and still have thousands left over in investment accounts. We all know that isn’t what’s happening in the real world. People are cashing out every last penny to be able to buy their first place because real estate is so damn expensive.
For the most part, I don’t care for insurance. I refuse to get life insurance until I have dependents. I have the bare minimum of car insurance. And I’m a freelancer with no health insurance. So I, personally, would never get layoff insurance. It makes no sense foe me.
But at the same time, there are thousands and thousands of Canadians who have disability and critical illness insurance. There isn’t really much difference between that and layoff insurance. For many of those people, layoff insurance makes more sense than keeping tens of thousands of dollars in the bank.