Emergency Fund Idea

[Neongreen]

Hi guys,
I was looking at emergency funds and had an interesting thought. I'm fairly young, so money invested now is pretty important, however I'm also self employed, so being financially stable is also pretty important. Previously I had a goal of a 12 month emergency fund, however I'm now starting to revise that.

I'm currently saving about 50% of my income per month, post tax. This is pretty regular, steady income. This means each month's savings is a month of emergency funding in case of job loss.

Here's the thought I had - the problem with investing your emergency funds in the market is that obviously if the market drops and then you lose your job or whatnot, you end up selling at precisely the wrong time.

What if you maintained a shorter or non-existent emergency fund, but as soon as the market drops more than 2-3% a month for 2 months in a row, start allocating your investment funds into an emergency fund. It's my belief that it's pretty rare to lose your job the moment the market starts turning south. And if you lost your job/had an emergency while the market was fine, you would immediately withdraw your emergency fund into cash.

Of course once an appropriate emergency fund has been secured, the money should then go straight back into the market. This may even assist with preventing you buying on the way down.

Thus the only way to be caught out would be to have a sudden large drop in the market the moment your job disappeared or an emergency cropped up.

What do you think? Too risky? Too complicated?

[LOL!]

Many folks have tiered series of assets that constitutes their emergency fund. This might be 2 weeks of expenses in checking, access to credit cards, a month in a savings account, 2 months in a short-term bond fund, and the rest in riskier funds. The idea is that one doesn't need 10 months of expenses instantly on a Thursday evening, so getting cash from this tiered set of assets is easy over a few days

Retired folks don't even have an emergency fund because they don't need to replace income in case of "loss of job".

Some folks use a Roth IRA to hold their emergency fund if they cannot do a separate emergency fund and still contribute to a Roth.

[samclem]

In the last 30 years there have been at least 20 instances were the NYSE shares lost over 4% in a single day--so a little less than once per year on average. Including once case where the shares were down over 22% in one day. And, it frequently goes back up a few percent just as quickly (so you'd buy back into the market? When? When it was back to some moving average?) You'd be in and out of the market a lot, with all the tax consequences that result from that.

It also encourages daily watching of the market, which (IMO) is not a great habit to have if one is accumulating funds.

I'd think it best to just put some money into your emergency fund. You can put most of it into a long-term CD and get a percent or so extra interest and just pay the penalty if you need it. Assess your actual needs carefully (could you cut costs to get by with less $$? Would there be some needed spending on education/marketing that would increase the amount you'd need to have in reserve?)

[Neongreen]

Samclem,
This strategy would minimize your in-and-out of the market. The only time you would sell is when you have lost your job, or an emergency has cropped up, in an up market.

This whole idea is that it manages where your contributions go as opposed to where your money is.

You'd also only check the market once a month, when you get paid.

[Meadbh]

I agree with samclem. Big dips happen more often than you expect and never when you expect them. Trying to live by the seat of your pants and watch the market daily is very stressful and may lead to too much "interference". Once you establish your emergency fund, it doesn't have to grow at the same rate as your other investments so after some time it will be a smaller percentage of the total. CDs are the safest place to park it, and a ladder allows you to balance liquidity in the short term with slightly higher rates in the long term rungs. A HISA is good for small amounts, and another vehicle, if you have a home, is a HELOC which you draw on only in an emergency. I use all of these and I am retired.

[mickeyd]

Quote:

What if you maintained a shorter or non-existent emergency fund, but as soon as the market drops more than 2-3% a month for 2 months in a row, start allocating your investment funds into an emergency fund.

That's an interesting market timing strategy, but I'm not smart enough to time the market. I don't use a EF as such, but my cash reserves (about 18 months of expenses) give me enough wiggle room to both sleep well and pay all of my bills.

[samclem]

Quote:

Originally Posted by Neongreen Samclem, This strategy would minimize your in-and-out of the market. The only time you would sell is when you have lost your job, or an emergency has cropped up, in an up market. This whole idea is that it manages where your contributions go as opposed to where your money is. You'd also only check the market once a month, when you get paid.

So, what you are really doing is not having any emergency fund unless stocks start going down. Until then, you'll just depend on the amount in your equities. If stocks do go down, you'll start building an emergency fund, but only when they've been declining for a couple of months. To get the full 12 months of "cushion" built up, it will take a total of 14 months from when stocks started down.
Questions I'd ask myself:
- When would I stop adding to the fund ? (Only after I have 12 months of expenses once the 2 month "trigger" is activated? As soon as stocks recovered to the price when I started [what is "holy" about that particular point? Answer: Nothing]?
- Do I need this emergency fund, or not? If I need it, and if this need is not predictable, why am I delaying the building of this fund based on external factors?
- Once the fund exists, do I keep it forever regardless of share prices? Why? My initial rationale was to not put $$ in unless share prices went down, so if they recover (?to what set-point?) should I now buy stocks with the fund and re-start the process?

From a pure math standpoint, having an emergency fund in your situation is a losing proposition. Just like buying car or life insurance. Over thousands of possible trials/outcomes, it would have been best for you to have your money fully invested in high-risk equities and taking your lumps if you need the money when share prices are down, especially if there is low correlation between the chances of needing that money and share prices. Only you know the likely correlation and whether having this emergency fund will provide comfort that is worth the drag/cost.

[Animorph]

I was happy enough to use my brokerage account as an emergency fund. I never had to use it. No EF allocation, just all in the normal retirement AA. A Roth account could work, since contributions (but not gains) can be withdrawn any time. If you lose your job while the market is down, you take an extra hit, but if that doesn't occur too often you've also had (or will have) plenty of time in the market to cushion that hit. International diversification may help as well.

If your job is a little less stable or more mobile than usual, you might think about 3-6 month's of expenses in easy to access cash and a portfolio withdrawal after that if necessary. If you will regularly see no income for a year, then 12+ months cash buffer would be nice.

I'm sort of 100% equities in retirement, so I may not be your most conservative example.

[MooreBonds]

I agree with the other posts that the market swings 2%-3% more often than you think, and it would require constant 'babysitting'.

Because of your self-employed situation, you could always have different tiers of funds marked for an emergency:

Tier used first: 1-2 months expenses in your checking account/online high yield savings account
Tier used second: 1-2 months in a 5-year CD that you could cash in quickly with a small interest penalty
Tier used third: 2-4 months in I-bonds, purchased in denominations which could be cashed in as necessary


The ratios above are just an example, and would depend on what rates you could get (some high yield savings accounts might get pretty close to a 5 year CD, so might be worth it just to put it all into a savings account and skip the 5 year CD), but would suggest some form of a tiered EF setup (with the higher yielding tiers used later) to try and reduce the drag on investment performance, which would allow the funds to at least try to match inflation - while at the same time giving you a pretty darn strong degree of certainty of being there for you when you need them, without a danger of getting a quick 5%-10% haircut by a market drop.

[RunningBum]

Not clear if you keep the emergency fund once you have it established, or if you put it into the market once it has recovered assuming you didn't need it, but that would seem like missing opportunities to buy on the dips and buying more higher instead. I'd think missing out on those swings would be worse than just keeping an emergency fund out of the market.

I was never one for keeping an emergency fund but I always felt I was pretty secure in my job until the last 2-3 years when my expertise was becoming somewhat obsolete, and by then I was ready enough to ER. Maybe I was just lucky, and it's probably not a great idea for many these days.

[target2019]

Quote:

Originally Posted by Neongreen Hi guys, I was looking at emergency funds and had an interesting thought. I'm fairly young, so money invested now is pretty important, however I'm also self employed, so being financially stable is also pretty important. Previously I had a goal of a 12 month emergency fund, however I'm now starting to revise that. I'm currently saving about 50% of my income per month, post tax. This is pretty regular, steady income. This means each month's savings is a month of emergency funding in case of job loss. Here's the thought I had - the problem with investing your emergency funds in the market is that obviously if the market drops and then you lose your job or whatnot, you end up selling at precisely the wrong time. What if you maintained a shorter or non-existent emergency fund, but as soon as the market drops more than 2-3% a month for 2 months in a row, start allocating your investment funds into an emergency fund. It's my belief that it's pretty rare to lose your job the moment the market starts turning south. And if you lost your job/had an emergency while the market was fine, you would immediately withdraw your emergency fund into cash. Of course once an appropriate emergency fund has been secured, the money should then go straight back into the market. This may even assist with preventing you buying on the way down. Thus the only way to be caught out would be to have a sudden large drop in the market the moment your job disappeared or an emergency cropped up. What do you think? Too risky? Too complicated?

It sounds too complicated. How are you managing the business income vs. your personal funds? Are they in separate accounts?

You need to have sufficient cash in your business account to allow for discretionary business investment, taxes, ordinary expenses and so on.

In your personal account you need to allow for the conventional emergency account wisdom to pay x months of expenses WHEN your self-employment hits nasty bumps.

In those two accounts, you'll notice that the total grows in good times. Keep in mind that in bad times the business account will dive. So it appears for long stretches that cash flow is great, and you have investable income. I'm raising a flag to let you know that a business dip is always around the corner.

What type of retirement account is set up for your self-employment? Are you maxing that?

[Neongreen]

Hi,
Thank you for all your input. I think some of the things you have pointed out are very fair points - especially buying on the dips is where the money is made. I haven't really thought out every nitty gritty detail on this, but think it poses an interesting bit of food for thought.

I'm based in New Zealand, where we have the luxury of 4%+ CDs and call accounts, but have significantly fewer retirement scheme options. Oh for the days of 9% CDs pre-GFC. I think we're doing fairly well since our Reserve Bank is only not raising our interest rates for fear of sending our currency higher than it already is.

At this stage I'm probably going to carry a 12 month EF, with a bit extra in my HELOC, and then figure out where to go from there.

[growing_older]

I'm a believer in the tiered approach to emergency funds. An emergency requiring quick access to cash is rare and not likely to be more than a month of expenses. A backing of credit (may not be available) for smoothing timing, and an investment portfolio generously larger than a recommended emergency fund has worked well for me. Now, after decades of this approach, I have earned enough return on the "emergency fund" part of my portfolio that it has paid for itself and even if I were to sell it hastily in a down 60% market, I'm still ahead of where I would have been in cash equivalents. Moving in and out of markets in anticipation of emergencies seems too complicated. If you really want to anticipate emergencies, perhaps you tap a HELOC and hold the cash until you think the emergency has passed, then pay it back off. You still risk the HELOC being frozen but the costs of your timing attempts are more clearly identified.

[galeno]

IMHO this is a bad idea. A young person should have AT LEAST 6 months of living expenses in a MMF, bank account, or buried in your back yard. You should also have adequate health, disability, and life insurance.

[growing_older]

Ever had an emergency that required immediate access to six months worth of cash? I never have. I can't even think of any.

A lot of emergency fund advice is confused with advice for needing a specific sum of money on a specific date in the not too distant future, in which case safe investment in cash or bank accounts makes sense. But once I have a portfolio of investments several times any emergency fund recommendation size, then the absolute need to access the funds on a moments notice really shouldn't restrict my choice of investments to cash equivalents.

And yes, adequate insurance is a very good idea.

[Meadbh]

Quote:

Originally Posted by Neongreen I'm based in New Zealand, where we have the luxury of 4%+ CDs and call accounts, but have significantly fewer retirement scheme options. Oh for the days of 9% CDs pre-GFC.

Inflation in NZ is currently up to 1.4% from <1% and peaked at 5.3% in late 2011.

New Zealand Inflation Rate | Actual Data | Forecasts | Calendar

Assuming 4% absolute return on CDs with inflation rate of 1.4%, your real return is 2.6%.

Assuming that the 9% absolute return on CDs coincided with the peak of inflation at 5.3%, your real rate of return would have been 3.7%.

In both cases that is an awesome return on a pretty risk free investment. In North America we are lucky if we see 1% real return.

[Neongreen]

Thank you Meadbh - that's correct. The inflation obviously takes a chunk out of the amounts, house prices are going a bit nuts in our largest city(20%+ YOY), and housing costs aren't reported in the CPI levels AFAIK so there's that. Pre GFC the rate of home price gain was something similar.

Due to the nature of my job, if I were to want to replace it, I would essentially need to create a new business(not too difficult but rather time consuming) or find a managerial level 9-5 job(urgh). Thus I think having a substantial EF is important - for my situation.

I don't typically carry much in the way of insurance, which may be a bit of a shock but the state provides pretty much all I need(accidental injury liability is not legally recognized and the state covers it all through a country wide insurance scheme - can't get sued, free/subsidized healthcare). I have no dependents but will probably evaluate getting a bit when I do have some.

Had the lady in the bank a few days ago try and sell me contents insurance. I said I don't need it and she countered with "What happens if you lose all your possessions tomorrow?". I think she was confused by my response that I could replace all my possessions the next day without a worry.

[inquisitive]

I am planning on having 4 months expenses in checking/savings accounts. The rest of my liquid funds I am planning on using in 6 months. I am willing to a take some risk rather than getting virtually nothing from a bank savings account and maybe 1% in a 6-month CD. I will divided the amount equally in the following 3 no load mutual funds, with expense ratios < 1%:

PONDX - multisector bond, including government, corporate, housing, derivatives. 12% US.
WTLTX - high yield bonds, 80% corporate, 95% US
PYVLX - large cap US value fund. seems to invest in companies with lower risk. was in the bottom 5% of large value mutual funds in performance over the last year

I will be happy getting 5% return. Since my income is more than my spending, I can put the difference in these funds as well. Would have gone with ETFs except would have commissions each month to add to these positions.

[tuixiu]

People with both taxable investments and a 401k can use the Stable Value Fund (if available) as an emergency fund that usually offers much better rates than savings accounts or short term CDs.

Say you need 20k for emergency fund, just maintain 20k in SVF and keep at least 20k of stocks in the taxable, if fan encounters manure just sell from the stock fund in taxable and transfer same amount in the 401k from stable value to stock fund.

Money market might be better in times of higher interest rates but right now with many SVFs throwing off 2% it ain't a bad deal at all for parking in safety.

[scrabbler1]

Add me to the list of those who use a tiered approach to the availability of one's own money.

My first tier is a small buffer (about $750) in my local bank's checking account over the minimum balance needed to avoid monthly account fees. This buffer, which I tap into fairly often, covers me for small, unforeseen expenses which can arise in a given month. If I need to get some extra cash or a monthly bill is a little bigger than expected or have to use my debit card (very rare I use it to begin with), then I am covered without having to do anything big.

My next tier is a larger amount (about $40k) in an intermediate-term muni bond fund. This covers me in case I have any larger, unforeseen expenses the first tier can't cover. This is a rare event, maybe once every 3-5 years. But this big blob of money is earning mostly tax-free interest every month, as I do not want to have any significant amount of my portfolio earning nearly zilch. I am willing to risk some loss to principal if I have to (rarely) tap into this account in return to the slow, steady (and mostly tax-free) return it gives me every month. This bond fund also has checkwriting privileges which makes the money more accessible, another nice feature. I can also electronically transfer money from there into my local bank's checking account in 1-2 business days and disburse funds from there.

Beyond these two tiers, I have other funds, stock and bond, which are less stable in price and/or less accessible than the above tiers, funds I would tap into only something really large such as buying a car (not a likely unforeseen event). I have tapped into these funds maybe once every 10+ years.