rethinking the "emergency fund"

[Berkshire Bull]

i was thinking this morning about emergency funds. many of us have them, in varying amounts, but how many of us have actually had to access them in the last 3, 5, 10, 20 years? meanwhile we're earning 2-3% and forgoing 7% or 10% by keeping that money out of longer term bonds or corporate equities. credit cards are not a suuitable means of purchasing "wants" but how about using them for needs. i'm sure many of us are currently contributing well in excess of our emergency funds toward our retirement each year. this is similar to the question whether to pay off the house or not, but it seems to me that one might be able to do better using most of their money to invest in longer-term vechicles and use revolving credit to pay for the unexpected. corporations do it via a bank line of credit. what do you guys and gals think?

 

[fire5soon]

To me an emergency fund is to be absolutely safe and liquid. The rest of the portfolio is for taking risk... not the emergency fund.

Also, as time passes, the emergency fund will be a tiny fraction of your overall assets (hopefully ) so mentally it won't be a big of an issue as far as "missed profits" go.

-Jay

 

[John Galt]

I can't stand "lazy money". I want every dollar to be working, since I am not. That said, I also have
"emergency funds" (if only in my head). This is money I could get to without penalty if needed. I go a bit further. I habitually consider what I would do in the
event of a personal economic meltdown, including
projecting various coping mechanisms to survive without
working through all manner of turmoil and tumult.
I think this is partly just genetic and partly having
retired with such a small pile.
BTW, my wife really hates this as she views me as being obsessive on the subject.

John Galt

 

[Marshac]

I agree with the two above me... I keep about 6 months of cash (this is different than 6 months worth of 'income') in a cash savings account... I use INGdirect since they currently pay out 2.2% interest, but I also keep a few grand in a savings account at my local bank just in case I need cash the same day (ING takes a few days to transfer). I could setup a CD ladder and get a higher RR, but that would defeat the purpose of having immediate cash reserves available if needed IMO.

 

[flipstress]

it seems to me that one might be able to do better using most of their money to invest in longer-term vechicles and use revolving credit to pay for the unexpected.  corporations do it via a bank line of credit.  what do you guys and gals think?

I agree with you. I keep my emergency funds in I-bonds. Currently, 88% of my investments are in equities (stocks & indexed stock mutual funds) and 12% are in I-bonds. (Equity in my house is not included here.) The 12% of I-bonds currently represents 9 months of expenses. I plan to add to the I-bonds portion until it becomes 20-30% of my non-house assets.

If I have an emergency, e.g., needing to visit my mom abroad, I'll use one of the credit-card checks that get sent to me with 0% APR for several months.

Any comment on the unwiseness or naivete of this/my approach is welcome.

 

[fire5soon]

Flipstress,
I have heard some stories of banks dragging their feet and taking several days to provide cash from redeemed I-Bonds. When in a money crunch a few days can seem like an eternity.

-Jay

 

[db]

The current buzz word seems to be conflating, but it seems to me that the above discussions conflate, or at least don't distingush, (1) an emergency fund to cover short-term emergencies, e.g. the roof falls in during a rain storm, (2) an emergency fund to cover living expenses if another source of income is shut off, e.g. being laid off from a job, and (3) an emergency fund to cover living expenses otherwise covered by withdrawals from a portfolio when we don't want to make such withdrawals, e.g. in a down market.

Marshac says he means 6 months of cash not 6 months of income, whatever 6 months of cash means. Others talk about needing immediate access to funds, which I presume means a type 1 emergency. But funding coverage of even type 2 and certainly type 3 emergencies (contingencies might be a more appropriate characterization) can be planned, with money moved from a less accessible to a more accessible form of fixed income investment in a way that mimimizes cost.

Thus, it seems appropriate to have an emergency fund in a money market fund at your bank or ING, depending how threatened you are by a two day delay, and a contingency fund elsewhere of your choosing that holds the propsect of greater earning, CDs, short-term bond fund, and so forth. A line of credit might be a goo choicefor emergencies, but not for contingencies.

db

 

[Cut-Throat]

forgoing 7% or 10% by keeping that money out of longer term bonds or corporate equities. credit cards are not a suuitable means of purchasing "wants" but how about using them for needs.

There is no way that I'm getting that much interest on my Fixed portion of my portfolio.

That being said, If I could get that much interest, I would use a credit card for emergency purchases.

BTW - Where do you get 7%-10%!! - I'm even hoping for less than half of that in my stock investments - Long term.

 

[Marshac]

Marshac says he means 6 months of cash not 6 months of income, whatever 6 months of cash means.

I make much more than I need to live on each month, so 6 months worth of "income" would be crazy... what I meant was 6 months worth of living expenses in cash.

When investing, some people like products such as Vanguards targeted retirement funds because they do the job for you... others take the other extreme and speculate on individual stocks...whichever method they chose for investing, they do so because it just seems like the right way. For me, knowing that I have a chunk of cash ready at all times is comforting... perhaps for you, the thought of losing $200 in interest a year in favor of higher returns (and relative loss of liquidity) is discomforting.... this only proves that there is no single plan which will fit everyone, so decide what will make you feel "safer", and stick with it.... don't worry about what other think (I know I won't) as the sums of money we're talking about here are not that large.

 

[cute fuzzy bunny]

No emergency fund here, and I dont need one.

I think its a relic of living from paycheck to paycheck, or some idea someone cobbled up that took on a life of its own.

As I understand it, its for when you have a major unexpected expense that would gobble up your liquid cash, resulting in your eating tree bark until you got some more money, or to continue to provide liquidity to your checking account to avoid taking money from your portfolio when you dont want to.

Hmm. I have four credit cards with 10-20k limits on each one. I have a home equity line of credit of $100k @4%. I carefully plan to limit the "major unexpected expenses". I have health, home and car insurance.

I keep a few months expenses in the checking account, my dividends flow directly into that account and once a month or so I tap some money out of my investments to keep that liquidity level, usually from the lowest yielding fund, unless somethings run up a lot and I want to skim something off the top. Its sort of like reverse dca-ing. I figure that while I might be taking a few bucks out while things are down and headed up, I'm also taking things out while things are up and might be headed down.

If my car does a blues brothers and implodes, I can get a low or zero rate loan on a new one. If half my house collapses, I have the heloc. If someone in the family gets sick or injured and has no insurance, I have a credit card.

So what emergencies are we holding all this cash aside for?

 

[brewer12345]

I keep about 5 months of expenses in ING accounts, half in a savings account, half in a 5 year CD. That way I boost my yield a bit and if I really need the cash, I can just take the penalties on the CD. Sometimes I consider boosting my e-fund a bit, but since I have a taxable portfolio with over two years worth of living expenses that I could tap or bowrrow against, it seems a bit silly.

The e-fund is less than 10% of my non home equity net worth, so I don't spend a lot of time sweating any lost earnings.

 

[UpandComer]

So what emergencies are we holding all this cash aside for?

I think most people worry about having an emergency and depending on credit - especially credit secured by your primary residence  - to fund emergencies.  I'd hate to have charge $10,000 worth of living expenses on a credit card is I lost my job, or worse, a HELOC then have to worry about paying that back plus my mortgage back every month.  If you default on the HELOC they can come and take the house just as if you didn't pay your mortgage (right?).

Personally, I break my $$ up into different funds. 1) Emergency Fund - not touched unless it's a true emergency like lost job, etc.  and 2) Set asides for recurring expenses like auto maintence, house maintenance and quarterly bills.  Works just fine because things like "oops, I need to replace the back tires" can come out of the auto set aside rather than the emergency fund.

 

[cute fuzzy bunny]

I suppose the fact that i dont have a mortgage or any other debt, which dramatically reduces my needs for monthly spending, makes riding out a tough spot via a credit card or heloc a lot less frightening.

I still cant envision what could happen that would result in any kind of significant draw down that would keep me awake at night.

But then again I agree with the thesis "There is no such thing as an emergency, just poor planning and resourcing".

 

[BigMoneyJim]

I have no emergency cash at the moment, and I probably won't. My credit cards are my emergency backup, backed by retirement funds if necessary.

However, I have no dependents, I rent an apartment, I still work and I have less than 2 years' salary in my retirement accounts. In my case I can't imagine an emergency that would be better handled if I had cash on hand, and in the past I've had the habit of spending any accessible cash lying around.

A small emergency, like my past three months of dental visits, towing, car repairs and car rentals go on the credit card until I catch up with salary. Medium emergencies like a total loss on the car would involve reducing my 401(k) contributions until I pay off a "new" car purchase. With job loss I have my expenses low enough I just need to find a new job fast or get a low-pay job to keep floating until a good job comes along. Catastrophic losses not covered by insurance are hard to imagine (unless I watch the evening news) and probably won't be helped by any sum of money, anyway.

If something unforseen comes up that requires me to take the 10% penalty for tapping my IRA/401(k), then "oh well". Most likely I'll come out ahead not keeping an emergency fund for the forseeable future.

 

[KB]

I keep a certain amount of cash on hand split up the way Upand comer mentioned. SOme for living expenses in case of lost job and some for irregular expenses like property tax or auto repairs. I also keep an amount to cover deductibles for home or auto.

I could probably use my credit card for these expenses but feel comfortable having 25K in my money market. All other money above monthly expenses is invested.

I was very poor for many years and never had a cent to fall back on. I'm probably over compensating, but feel much better having that much cash on hand.

 

[Zipper]

Your health is your most precious commodity. You can have the best plans in the world, but your HLOC and credit cards are only going to carry you so far, and then what? A fatal heart attack or cancer can be murder on your dependents. A stroke can be the worst of all nightmares.

 

[cute fuzzy bunny]

As I mentioned, I have and have always maintained full health insurance.

Anybody that doesnt is gambling, and gamblers always end up losing at some point.

I guess if I was uninsured or underinsured, I'd keep ready access to more cash or increase my liquidity to compensate, but I'd think the lost opportunity costs on that money would outweigh the costs of insurance. But then I know some people in some areas arent insurable and/or the costs are ridiculous. Fortunately I chose to live in a place that has a risk pool and reasonable insurance costs.

 

[ESRBob]

No emergency fund here, and I dont need one.

I think its a relic of living from paycheck to paycheck, or some idea someone cobbled up that took on a life of its own.

I am with TH on this one: basically the mutual fund industry, unnoticed by lots of people, has given us near perfect liquidity from what used to be relatively 'illiquid' investments -- stocks and bonds . They were illiquid not only for the fact that a bond might not have a ready market, but also for the fat commissions and spreads you faced when you needed to sell in a hurry. Plus, we were taught to worry about selling assets when they were 'down' -- a bad thing. Sell a vanguard bond fund online -- and its there for you the next day -- no commission, no spread, no lumpiness (needing 5k and having to sell a 10k bond)

You may wish to hold cash as some sort of volatility-dampening strategy or just 'cause your feeling a little skittish or are waiting to put it to work in a truly illiquid investment (limited partner in a building or venture capital investment), but I think it makes no sense to hold cash for 'emergencies' when you can get cash from any of your mutual funds in a day, and credit for everything you'd need to tie you over until then.

Setting up a debit card on a sweep account with one of the major brokerage firms can be handy, too. (Buy some bonds at issue (no spread) and leave them there for years, don't make any trades, and get the free debit card (no annual fees, no late fees). Worked for me at Smith Barney, and the broker is chastened enough that he never calls.

Anyway, touch wood, haven't had an 'emergency' ever that required planning like this.

I think 0-4% cash is plenty -- if nothing else you can draw your SWR from the cash over the course of the year and re-fill it next January when you re-balance.

ESRBob

 

[charlie]

I think emergency funds make the most sense for
younger folks still working, raising kids, and having a
relatively hard time paying the monthly expenses.
For them, losing a job could be a disaster and might
cause bankruptcy if there were no emergency fund to
fall back on.

Cheers,

Charlie

 

[Jane]

Your health is your most precious commodity. You can have the best plans in the world, but your HLOC and credit cards are only going to carry you so far, and then what? A fatal heart attack or cancer can be murder on your dependents. A stroke can be the worst of all nightmares.

I agree with you. So I exercise and eat lots of veggies and fruits. But just in case:

I have a min of 2 months of expenses in my chequing account for: 1. Avoid bank charges 2. "Small" emergencies such as car needs repair, family emergency etc.

I have a min 4 months of expenses in ING savings account for bigger emergencies: stove needs to be replaced, job lost etc.

I have health, life, disability, condo and car insurance - for who knows what (health, life and disability insurance comes with the job). And before you ask, yes, I do have will and power of attorney.

I do use cc but always paid it off every month.

I have LOC at prime with my bank that I have not yet used (hopefully never need to) as the last resort.

I feel safe already

Jane

 

[UpandComer]

I guess it just all boils down to your comfort level. If you listen to folks like Suze Orman, they always tell you to have 6-8 months living expenses in some sort of liquid investment.  To most folks that means cash on hand.  Now, I'm starting to see the wisdom in what the doubters are saying.  Rather than setting a target for 6 months living expense, I'm limiting it to a dollar amount ($10K). After I amass that much in my savings account I'll start putting my $$ in investments that may yield higher returns.

 

[Marshac]

I'm limiting it to a dollar amount ($10K).

I think that for a lot of people, $10k is the reserve.... I know it is for me. I don't think anyone was advocating sitting on top of $100k in a checking account yielding .25% interest.

 

[cute fuzzy bunny]

You might be surprised to find out how much a lot of people DO have sitting in a checking or savings account...

 

[Marshac]

You might be surprised to find out how much a lot of people DO have sitting in a checking or savings account...

Lets find out... i'll start:

Checking: today was pay-day, so I probably have about $2500 in there....by monday (automatic EFTs to other accounts) it should be down to about $900.

Savings: ~$10-12k in various accounts.

 

[flipstress]

I have heard some stories of banks dragging their feet and taking several days to provide cash from redeemed I-Bonds.  When in a money crunch a few days can seem like an eternity.

Thanks for the warning, fire5soon. I did call my credit union and I asked how long it would take to redeem my paper I-bonds. The customer-service rep estimated 3-5 minutes per bond, if all goes well. (Hmmm, now I wonder what possible horrible things could go wrong with redeeming I-bonds? ...)

Now, I assume that if I went with Treasury Direct and established an account to purchase new I-bonds, I could redeem those electronically overnight via their online services.