FOLLOWING FRANCIS, FOLLOWING CHRIST: RULE 29C: CREDIT CARDS: PART 2: WHY YOUR CREDIT CARD NEEDS A RESERVE FUND AND HOW TO BUILD IT

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I’ll never forget the day I was sitting in church and heard those famous words of Christ –“Take up your cross daily and follow me.” How quaint, I thought. After all, in this day and age, and especially in this country, no one is crucified. How, then, is one supposed to “take up your cross daily”?

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For those of us in CFP, who are laypeople living as best we can a religious rule of life, the answer is pretty simple: Our cross is living the six elements of the CFP Rule – prayer, fasting and abstinence, clothing, almsgiving, works of charity, and becoming debt-free and tithing 10 percent of our income. Becoming debt-free and tithing is the layperson’s equivalent of the religious vow of poverty.

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Imagine this: You’ve got your budget fine-tuned. You’re able to pay all your bills. But there’s very little room for error. You’re driving down the highway when one of your tires blows. Or you take your car to the dealer for a major service, and he says you need new set of tires. Or you take your beloved pet to the vet, and he tells you that your pet needs its teeth cleaned and one extracted --and it will cost $900.

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If a person is maxed out on credit cards and living paycheck to paycheck, a big, unexpected expense can derail that individual from becoming debt free. That’s why personal finance experts recommend at least a $1,000 reserve fund as the first step in paying off one’s debts.

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I actually think it’s the second step. The first step is to stop charging and start using only cash and/or debit cards. Traveling is an exception. Hotels will place significant holds -- $500 or more -- against debit cards to assure you pay for “incidentals.”

The second step is to build a reserve fund (a catastrophe fund). If one is living on the edge financially, a new set of tires, loss of a job, replacing a roof or boiler, or a huge vet bill can be a catastrophe. Karen Sadock, a life-pledged and privately vowed penitent tells her own story:

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“Our big thrills came from November 16-December 16, when the 115-year-old bathtub drainpipe broke and water cascaded through the parlor and front hall ceilings, imperiling the hall wallpaper and the floors in both rooms. The repair involved demolition, industrial dryers roaring nonstop for 3 days, new drywall, and painting the entire parlor. That whole process took just nine days and left us wondering if it was all just a bad dream. Like it never happened. Insurance covered most of it. 

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“But WAIT!! There’s MORE!!!

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“Monday, December 14, was the annual boiler inspection. Geoff painted the basement floor this summer and had been fretting about some rust around the boiler. The plumber discovered severe corrosion inside and shut the thing down. But we got lucky again. He spent 90 minutes on the phone, locating the right boiler for our space and switching personnel from other projects in order to put two guys experienced with steam systems on our job. Providentially, the temperature never went below 25. We holed up in the library. 

“The crew showed up with the boiler the next morning and took out the old monster. By 6:00 pm, the new boiler was percolating, the radiators were hissing, and we took our jackets off. The whole catastrophe, starting from the broken pipe, came to $24,000 - with only about $6,000 covered by insurance.”

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Over the years, the Sadocks had built up a reserve fund – they call it their catastrophe fund – sufficient to pay the $18,000 that wasn’t covered by insurance. “I’m so grateful that we throw money regularly into the disaster fund because none of this required gouging into the daily running money,” she says. “Keeping a crisis fund is the best tranquilizer in the world. And good insurance. Gotta have good insurance.”

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Here’s another example, this time from the business world. In 1947, Nelson Poynter purchased the St. Petersburg (Fla.) Times, the No. 2 newspaper in St. Petersburg, from his father who had loaded the paper with debt to build a dog racing park. Nelson had been unable to pay the monthly payment on the newspaper’s mortgage. So, the insurance company that held the mortgage foreclosed.

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Poytner scrambled around, raised the money and succeeded in recovering the newspaper. He then sat down and wrote a document, “Standards of Ownership for a Newspaper or Broadcasting Enterprise” telling his “heirs, successors and assigns” how his newspaper should be run.

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No. 11 on the list: “To maintain a strong editorial policy, a newspaper or broadcasting station must be in a strong financial position. Reserves must be built. Debt must be reduced or extinguished.” That’s exactly what CFP Constitutions Rule 29c requires of us.

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By the time I joined the Times staff in the mid-1960s, the paper had built reserves that enabled it to simply write a check anytime it had to expand its press lines. That policy served it well during the 2008-2009 Great Recession when many papers barely held on and its biggest competitor, the Tampa Tribune, heavily laden with debt, was dealt a death blow. Following the demise of the Tribune, the Times expanded into Tampa and is now called the Tampa Bay Times.

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So, how do you start building the catastrophe fund? Apply the same principles used in the rest of CFP formation process, a step at a time, and remember, “slow and steady win the race.” One fund can serve multiple purposes. You don’t have to have one fund just in case you lose your job, a second fund to replace the roof on your house, a third fund to replace the boiler. Merge your needs into one fund.

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I think there are two – and for some people three -- entirely different types of situations we all face. One is short-term, such as needing a new set of tires. If we own a car, we know we eventually will need a new set, we just don’t know when. The second is the medium-term, but expected need for cash, such as a teacher on a 10-month contract who needs money to pay bills over the summer vacation. The third is anticipated long-term expenses such as replacing a roof, HVAC system or major appliances.

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To cover the short-term, unexpected bill, such as replacing a set of tires, Dave Ramsey and other personal finance experts all recommend having at least $1,000 in a savings account. You can set your own funding goal, based on what you can afford to set aside right now.

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If you can afford $250 a month, you will have built your $1,000 reserve in just four months. If you can afford only $100 a month, you will have built your $1,000 reserve in 10 months. If you can afford just $50 a month, it will take a bit longer – about 20 months.

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Once you have reached your $1,000 goal, continue contributing a little each month to this account. That way you’ll be able to cover a situation where in the same year you need to buy a new set of tires for your car and replace your washer-dryer.

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 If you are a worker who knows your income will fall during part of the year, such as a teacher who is paid 10 months of the year, or a salesperson paid on commission, the next goal is to have the same amount of money available for spending every month of the year. The math is fairly simple:

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Take the full amount of your after-tax income from those 10 months and divide by 12. That will tell you the maximum amount you can spend each month. Let’s say your after-tax income on a 12-month basis is $5,000 a month, or $60,000 a year. But you get paid only 10 months a year, or $6,000 a month. So, to be able to have $5,000 a month over the summer when you don’t get paid, you need to save $1,000 each month for 10 months.

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Most payroll systems will permit you to deposit your paycheck into at least two bank accounts. So, have the payroll department simply send $5,000 to your checking account and $1,000 a month to your “summer savings account.” In the summer, when you’re not getting paid, transfer $5,000 each month from your summer savings account to your checking account so you can pay your regular household bills without missing a beat.

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For longer-term expenses, such as replacing your roof or HVAC system, follow the Sadock’s example. They knew they would have to replace their roof in five years. They determined what it would cost to replace it today, divided that amount by 60 months and began saving that amount each month.        

   

The dollar amounts of these longer-term expenses can be daunting. But the actual amount needed to save each month can be relatively miniscule. We recently replaced our roof. It has a 25-year, or 300-month, life. Our roof cost $18,000. Divide that by 300 months, and we need to set aside just $60 a month to pay for a new roof 25 years from now. You can include replacing your HVAC system, autos and major appliances in the same way if you wish. Simply divide the cost of replacement now by their remaining life span and save that amount.

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Not everyone needs long-term reserves (a catastrophe fund). When you’re living a debt-free life, the catastrophe fund holds money that you know you’re going to have to spend at some point. Someone renting a house doesn’t need to worry about a new roof or a new furnace. But if they do have a car, it’s going to need new tires at some point. Perhaps the only expense that person may need to plan for is that $800 set of new tires. If his tires are expected to last four years (or 48 months), that person needs to set aside just $16.67 a month to be able to buy new tires when needed without having to either disrupt normal spending or charge on a credit card.

What if you need long-term reserves but can’t immediately start to build them? Do what you can – start with saving that initial $1,000. To be sure, building reserves requires adjustments, perhaps eliminating a latte every day or taking your lunch to work rather than buying it. Consider that a penance, and the bigger the adjustment, the sweeter the penance.

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How is building a reserve fund a penance? The penitential life is giving up something good for something better. In secular terms, being able to sail through a financial crisis without getting in debt, or, if you are still getting out of debt, without having to take on more debt is a good thing.

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In spiritual terms, it’s letting go of attachments that keep us from doing God’s will. For a penitent, God’s will is expressed in Rule 29c, to begin at once to pay off our debts, and in Romans 13:8 where St. Paul tells us to “owe nothing to anyone except to love one another” (Romans 13:8). So, if we have to give up a latte or carry our lunch to work, that’s a fine penance.

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In at least two New Testament parables, Jesus directly addresses questions about being ready for the future. In the parable of the Wise and Foolish Virgin (Matthew 25:1-13), Jesus recounts the tale of a wedding feast in which some of the guest virgins run out of oil for their lamps before the bridegroom appears. they go out to get some more oil, the bridegroom appears, and they are shut out of the feast. To be sure, there is a spiritual message here: One never knows when the Lord will come for a second time. Live in such a way that whenever He appears, you will be admitted to Heaven whether you are alive at the moment of His coming, have just passed away, or had died 5,000 years earlier.

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But Jesus also told us to be “both as cunning (or wise) as serpents and as simple as doves.” (Matt. 10:16). To be as wise as serpents means to be prudent, careful and intelligent. Not being ready for those bills we could reasonably anticipate – the new tires or the new boiler, for instance -- is equivalent to being a virgin who runs out of oil and has to leave the wedding feast. So, prepare for them. Have a reserve fund.

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To be as “simple as doves” means to ignore those who will tell us there is “good debt.” There is never “good debt.” There may be necessary debt, such as using a mortgage to buy a house. But the CFP rule doesn’t exempt necessary debt. To live a penitential life, all debt must be paid off. Necessary debt might be incurred, but it should be paid off as quickly as possible.

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Jesus drives home this message in in the parable about a house built with a strong foundation vs. a house built on shifting sand. Jesus tells us that “anyone who listens to my teaching and follows it is wise, like a person who builds a house on solid rock. Though the rain comes in torrents and the floodwaters rise and the winds beat against that house, it won’t collapse because it is built on bedrock. But anyone who hears my teaching and doesn’t obey is foolish, like a person who builds a house on sand. When the rains and floods come and the winds beat against that house, it will collapse with a mighty crash.” (Matt. 7:24-27).

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Again, there are two messages here. One is spiritual. Do what Jesus says in order to attain eternal life. The other is secular. People of his time often saw a poorly constructed house washed away in a storm. As penitents, we should build our financial houses on solid rock. That means we should have strong reserve funds so that our financial house isn’t washed away by a storm – whether that storm is a new set of tires for our car or a new boiler for our house.   – Joel Whitaker, CFP

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Next month: How to pay off your credit cards.