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Proper Margin

Proper Margin
Charles Crowley, CFP®, AIF®
March 11, 2019

I was recently asked by a cousin during a New Year’s Day lunch conversation, “If you had to name the one key to starting a good financial plan at my age, what would it be?” My reply came without hesitation – “Margin.”

To provide context as to how the question arose, he and his wife are in their late 20’s. They married fairly young, have already survived some incredibly difficult life events together, purchased their first home, adopted two dogs, and are now expecting their first child. He understands the value of a dollar, the meaning of hard work, and is, quite frankly, one of the most principled men I know. So, what he was really asking was simply this: If we are looking to REALLY start getting our act together financially, and begin to put ourselves on a path to build wealth, where should we start? By the look on his face, my cousin was expecting something quite different in response, but quickly caught on to what I meant as we continued to chat.

The complete answer to his question is threefold. To begin establishing a solid financial footing, there are three main pillars to commit to, especially early on:

  1. Frugality – You have to be able to deny yourself instant gratification. As Dave Ramsey often says, “Live like no one else today so that later you can live and give like no one else.”
  2. Budgeting – You have to know where your money is going in order to make it work for you. It isn’t necessarily fun, but 110% necessary.
  3. Margin – You have to have Margin. This, in my opinion, is the most critical piece of the equation.

You see, the type of margin I am referring to has absolutely zero to do with what type of investment account you have. It is something you create. The terminology I use here actually comes from a message in a series called “Breathing Room” from Pastor Andy Stanley.1 It is a message that I heard several years back, and a concept I believe is brilliantly applicable. Stanley says, and I’m paraphrasing here, when you create a buffer between your current status and your limit(s), you naturally give yourself breathing room. He goes on in that series to apply this concept to other facets of life, but, speaking just within the context of money, that margin or buffer really is your contingency fund (not to be confused with emergency fund which I will explain later). If you run a quick Google search on the term margin one definition is “an amount of something included so as to be sure of success or safety.” So, I think you get the picture – when you establish a coffer of money earmarked solely for the purpose of handling the unexpected expenses, you’re not constantly undermining your long-term savings to cover items or events brought about by our good friend, Murphy (creator of “Murphy’s Law”). Margin takes intentionality and discipline but is a critical first step to successfully building up wealth. I recently saw a statistic that said over 40% of working adults can’t cover a $400 “emergency”2. In my work, I have unfortunately seen firsthand how some of the best laid financial plans can be completely unraveled by the lack of room for contingencies. If you have no buffer between financial sufficiency and life’s crises, your retirement savings are eaten alive as a result!

So, how is this financial margin attained? By establishing two things – your contingency funds and your emergency funds. I personally think that these two things are very different. The contingency funds should be for very short-term needs. The unexpected expense can certainly be a short-lived “emergency”, but often times isn’t. It usually is just something that was unexpected or not planned for within the budget. Tires or repair work on the car, an unforeseen medical procedure where a deductible has to be paid, or dental work (I hear this one often!) all fall into this category. To contrast the contingency funds with emergency funds, I believe that the traditional emergency funds are to cover and protect you against a more prolonged, more financially worrisome event, such as losing your income from your company’s downsizing or a debilitating injury preventing you from working for months. Some of these risks can and should be offset by proper insurance coverage, but there still are many situations where you need adequate reserves to tide you over for a longer period of time.

Naturally, the next thing to address is determining how much should be in each pot. For contingency funds, I personally operate on one rule: make sure all of the deductibles are covered if they all came due at once. I generally use the example of a car accident. What happens if in one week you had to pay the full deductible on your auto insurance to get your car fixed plus the deductible on your health insurance for a procedure or stint in the hospital? For the emergency funds, a general rule of thumb is three to six months’ worth of living expenses, depending on where you truly feel comfortable. We often tell clients who are married and a one income household to err on the side of six months. If you are single and/or a two-income household three months may be adequate.

Once you have determined how much, where to hold the funds is also critical. For the contingency funds, because of the potentially frequent usage, a traditional savings account at the bank likely will suffice. You may sacrifice a few basis points on your interest rate, but the fast access is the primary concern. You want something where you can easily transfer money electronically into your checking account. I’d also point out that we aren’t usually talking a large sum here, maybe a few thousand dollars. So, it isn’t as if you would be missing out on significant interest. The emergency fund is a bit different. Generally speaking, the dollar amount is larger and the usage less frequent. A higher yielding money market investment is typically more fitting for these funds. But the vehicle you use should still be very safe and accessible. You will want to ensure this too has proper linkages to your bank account.

We are in the season of change – with new year’s resolutions abounding, and, hopefully, most still well intact in the first quarter of the year. If setting yourself up for a better 2019 financially is part of those new year’s goals, take inventory of where you sit from a cash reserves perspective. Building in the type of cushion I’m talking about in your financial life can seem daunting at first, especially if you are someone who isn’t necessarily used to being on a budget month-to-month. Over time, I bet you would be surprised how quickly these cash sums can build up with the right level of commitment. I am certainly not implying that it is always easy. The challenge of not utilizing the cash for anything other than the intended purpose many times feels like a contradiction to our nature as humans. But that is the test. My wife and I have a magnet on our fridge that reads, “If it doesn’t challenge you, it doesn’t change you.” Cliché, but it’s true. The sting of the budgetary sacrifices along the way quickly becomes a distant memory when the margin created removes much of the uncertainty for you, allowing you to simply move forward with confidence.

1 Andy Stanley: https://www.youtube.com/watch?v=VupiR_ebs5c
2 https://www.marketwatch.com/story/why-4-in-10-adults-cant-cover-a-400-emergency-expense-2018-05-22

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