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Benefits of a larger emergency fund
Old 07-29-2009, 12:18 PM   #1
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Benefits of a larger emergency fund

I've generally followed the rule-of-thumb of keeping an emergency fund stocked with 6 months of post-layoff expenses (which would include COBRA payments for health insurance). With that set aside, the rest of my savings went first into tax-favored retirement accounts, then toward any specific savings goals (home down payment, new car, etc.), and finally toward taxable long-term investments.

During this recession, I've read a good deal of advice that (wisely) suggested a larger 12-month emergency fund is a good idea in the economic environment due to the potential for a lengthy period of unemployment. Back in the fall I had reached pretty much the same conclusion after reading about continuing job loss in my field, so I beefed up the emergency fund to 12 months.

In the back of my mind, I had sort of assumed that at some point I would reduce my emergency fund to 6 months of living expenses again, once the economy improved. But thinking about it last night, I realized that it's better for me to keep my emergency fund at a level that I would need it to be at when a true economic emergency hits -- like this recession. For me this means keeping a 12 month emergency fund at all times.

While part of me doesn't like this much cash sitting on the sidelines, I think the benefit of keeping the emergency fund at "crisis level" is that, well, for starters I'll be prepared when/if the next economic crisis hits.

Also, I think it's a pretty good bet that future period of high-risk for unemployment will coincide with general problems in the economy, which typically go hand-in-hand with stock market crashes. During the next crash (which may be around the corner or a decade from now, who knows) I want to be able to take more advantage of the opportunity to buy low. I can't do that if I'm silmutaneously diverting investment dollars to beefing up my emergency fund in times of economic stress. During the past 9 months, I've continued maxing out my tax-favored options, but I have had the extra savings each month to do as much taxable long-term investment as I would have liked, because of the diversion to increase the emergency fund.

So, I'm looking at keeping my emergency fund at "crisis level" from now on, which for me is 12 months. I'm going to resist the temptation to trim back my emergency fund when the good times roll again.
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Old 07-29-2009, 12:23 PM   #2
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As long as we are still dependent on paychecks from an employer, I don't think I could ever again feel like 6 months of expenses is adequate. I cranked it up to over 18 months earlier this year (thanks to being debt-free) and plan to maintain it at close to 12 months or more at all times as layoff insurance.

During the depth of the recession (which for us was until my wife found a j*b), I know it was that nuclear-sized emergency fund together with being completely debt free that kept me from being a basket case. The calming effect it had on me, the feeling that I know we could weather the storm, well, that's hard to put a price on since it really does affect your health and well-being.
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Old 07-29-2009, 12:40 PM   #3
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I cranked it up to over 18 months earlier this year (thanks to being debt-free) and plan to maintain it at close to 12 months or more at all times as layoff insurance.
Of course, the gaping hole in my theory may be when/if the next crisis rolls around, I may think "gee, I guess I should beef up my emergency fund to 18 months instead of buying more stocks ..."

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Old 07-29-2009, 12:46 PM   #4
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The main reason it got to 18 months or more is because we were deferring projects around the house. We had the cash to pay for them, but were afraid to reduce liquidity in this economy, especially as long as my paycheck represented a single point failure. Once my better half starts her new j*b in three weeks, we'll start spending the portion that we set aside for home improvements, and then we'll be back to around 9-12 months, give or take.
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Old 07-29-2009, 01:02 PM   #5
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I think that, for us, a 12-month EF is a minimum. Whether the economy improves or not, we live with the knowledge that we could lose our jobs at any time and that getting new jobs would most likely require moving somewhere else. So we have to remain prepared at all times for that possibility.
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Old 07-29-2009, 01:16 PM   #6
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A 12-month EF is also our goal. We're halfway there! We do have some home improvement projects we're going to pay cash for in the next month or so and then we can start slamming that money back into the EF. Looking forward to the day when we have 12 months in there.

I've found that having a plan really helps with the anxiety, nearly as much as the EF does.
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Old 07-29-2009, 01:40 PM   #7
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For you folks praising the benefits of large cash holdings, is there an upper limit where you feel you might be holding too much cash? Would 100% cash be too much? How about 50%? 20%?

Let's consider cash to be immediately available, liquid cash such as MMF's, passbook savings accounts, checking accounts, CD's due in 90 days or less and that sort of thing. Longer term CD's, short term bond funds, etc., really aren't cash.
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Old 07-29-2009, 02:18 PM   #8
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For you folks praising the benefits of large cash holdings, is there an upper limit where you feel you might be holding too much cash? Would 100% cash be too much? How about 50%? 20%?

Let's consider cash to be immediately available, liquid cash such as MMF's, passbook savings accounts, checking accounts, CD's due in 90 days or less and that sort of thing. Longer term CD's, short term bond funds, etc., really aren't cash.
Well, longer term CDs can be considered cash, for example: my 12 month emergency fund consists of 12 one-year CDs, each with one month's living expenses. But I take your point -- money for an emergency fund must be sufficiently liquid.

I don't think of my emergency fund in terms of my overall asset allocation, so I haven't thought of it in % terms. I think an emergency fund should be stocked with adequate # of months living expenses (for me, I've decided that in times of economic stress I need 12 months worth to feel it's enough) before any other investments are made.

So yes, in theory that means for a new saver/investor just starting out that may mean a brief period of time where they have no other investments and thus are 100% in "cash" because their only savings is the emergency fund. But that would be a temporary situation, only until the desired # of months are reached in the emergency fund. Then, new investments for FIRE can be made using whatever the appropriate asset allocation would be (and I wouldn't factor the emergency fund into that asset allocation calculation at all).
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Old 07-29-2009, 02:55 PM   #9
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DW and I both work and only keep 6 months of expenses in our EF. If one or both of us were laid off we'd collect unemployment (or short-term disability if injured) at healthy rates and that would increase our expense coverage to 9-12 months easily. Any severance package on top of being laid off (common practice even these days at our companies - I know I'd get 2.5 months based on tenure) would be even further cushion.

Dunno, maybe I'm missing something....
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Old 07-29-2009, 04:06 PM   #10
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DH is currently working, however I quit my job last year.

We have shifted our portfolio to 55% cash. We do not bother with bonds. All our cash is in term deposits in Australia earning 6%+ for 5 years. Obviously this works for us because we are Australian and that will eventually be our place of residence. As interest rates are about to increase in Oz I am holding off before I invest the additional funds we have realised by cashing in some investments.

If we were having to invest our cash here in the US it would probably be a different issue as interest rates are so low.

We are plotting at the moment to hopefully make our escape on a permanent basis sometime next year.
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Old 07-29-2009, 06:00 PM   #11
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DH is currently working, however I quit my job last year.

We have shifted our portfolio to 55% cash. We do not bother with bonds. All our cash is in term deposits in Australia earning 6%+ for 5 years. Obviously this works for us because we are Australian and that will eventually be our place of residence. As interest rates are about to increase in Oz I am holding off before I invest the additional funds we have realised by cashing in some investments.

If we were having to invest our cash here in the US it would probably be a different issue as interest rates are so low.

We are plotting at the moment to hopefully make our escape on a permanent basis sometime next year.
I think a lack of agreed upon terminology and definitions makes these discussions difficult. For example, many would not consider your portfolio 55% cash since 5 yr CD's are usually thought of as "fixed" investments.

I like your strategy. I just wouldn't refer to it as 55% cash.

Right now my portfolio (including what some are calling "emergency funds") is 46% equities, 50% fixed and 4% cash. But if I considered CD's and bonds with five year maturities to be cash, I'd be more like 46%, 30%, 24% in round numbers.

No one is right or wrong here...... but different definitions and use of terminology is causing some apples to oranges comparisons. We need to keep that in mind.
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Old 07-29-2009, 06:25 PM   #12
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I have about a one year emergency fund available in a checking and money market. I plan to put every available dollar into building this up. When things hit the fan last fall, I had too much in equities, bonds and retirement accounts and not enough cash on hand. As I still work, I am rectifying this situation with my salary. I don't want to have to sell things out of desperation. I have quite a bit tied up in real estate but plan to just sit things out on this front also.
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Old 07-29-2009, 06:35 PM   #13
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I like your strategy. I just wouldn't refer to it as 55% cash.

Right now my portfolio (including what some are calling "emergency funds") is 46% equities, 50% fixed and 4% cash. But if I considered CD's and bonds with five year maturities to be cash, I'd be more like 46%, 30%, 24% in round numbers.

No one is right or wrong here...... but different definitions and use of terminology is causing some apples to oranges comparisons. We need to keep that in mind.
Maybe our term deposits are likely different from CDs then as I can go to my bank and withdraw the funds today. There is some penalty with regards to interest depending on how long the funds have been invested. A multi- year term deposit in Australia pays interest annually, regardless of the term of the investment. So I guess a TD in deposit doesn't not have any maturity to it as it is available on call.

But as you say it is all just semantics, a CD is still actually cash because isn't it still callable regardless of it's terms?
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Too much cash in my emergency fund?
Old 07-29-2009, 08:56 PM   #14
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Too much cash in my emergency fund?

I have about 10 months saved up in a money market account which is getting 2%. I have also contributed about 4 months to a Roth IRA that I could use as a second tier emergency fund. My wife and I are fortunate to have 2 1/2 stable jobs and would get about 2 months worth in a severance package if we get laid off. Would it make sense to transfer a couple months worth from my MM into a taxable account?
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Old 07-29-2009, 09:14 PM   #15
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Uh, your money market is a taxable account, so are you asking if you should transfer from a taxable account to a taxable account? I wouldn't bother since they are both a taxable account.
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Old 07-29-2009, 09:15 PM   #16
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Uh, your money market is a taxable account, so are you asking if you should transfer from a taxable account to a taxable account? I wouldn't bother since they are both a taxable account.
I assume he means "taxable brokerage (or mutual fund) account," which would be more aggressively invested rather than in cash equivalents.
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Old 07-29-2009, 09:29 PM   #17
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Uh, your money market is a taxable account, so are you asking if you should transfer from a taxable account to a taxable account? I wouldn't bother since they are both a taxable account.
Yeah, what I wrote doesn't make much sense. What I meant is transfer it to a brokerage account and invest in a stock fund - specifically Vanguard's Total Stock Market Index.
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Old 07-29-2009, 09:33 PM   #18
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Yeah, what I wrote doesn't make much sense. What I meant transfer it to a brokerage account and invest in a stock fund - like Vanguard's Total Stock Market Index.
You are the best judge of all the factors in your personal situation -- your tolerance for assuming more risk, the level of security in your current income streams, that sort of thing. It's tempting to take more risk when the "safe" alternative is 0.3% in a MMF, but you have to ask yourself: if the "perfect storm" of another market swoon together with a layoff were to occur, would this decision likely cause a hardship? Would you be in a position where you have to sell stocks at a large loss in order to pay the bills?

If not, maybe taking the extra risk in stock investing is appropriate. If so, I'd err on the side of liquidity in this economy, personally...
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"Hey, for every ten dollars, that's another hour that I have to be in the work place. That's an hour of my life. And my life is a very finite thing. I have only 'x' number of hours left before I'm dead. So how do I want to use these hours of my life? Do I want to use them just spending it on more crap and more stuff, or do I want to start getting a handle on it and using my life more intelligently?" -- Joe Dominguez (1938 - 1997)

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