Safety Net Funds, why Traditional Advice is Wrong.

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Safety Net Funds, why Traditional Advice is Wrong.

Postby justus » Sun Sep 01, 2013 7:50 pm

I recently came across this entry on betterment's site. What do you think? Should you invest your emergency fund in 40% stocks?

https://www.betterment.com/blog/2013/08 ... -is-wrong/
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby Rob5TCP » Sun Sep 01, 2013 8:04 pm

They seem to assume you won't need your safety net 3-6 months after you set it up. Had this been 2008 and you lost your job in a bad econmoy, you don't want a safety net that has just been reduced by half. Plus you might be forced to liquidate at just the worst time.

True, if you don't need it for 5, 10, 20 years, it would be better in equities. But, you have no idea idea whether you will need it in 25 years / months / or even weeks. For that reason, I would keep it as safe as possible. Take risk on other, longer term investments, that you can comfortable ride out market swings.
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby livesoft » Sun Sep 01, 2013 8:16 pm

Only 40% stocks? No, you should be 100% stocks. But then your emergency fund has to be twice the size just in case stocks drop by 50%. The article basically says to do something similar: stocks plus a larger emergency fund.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby Wolkenspiel » Sun Sep 01, 2013 8:28 pm

livesoft wrote:Only 40% stocks? No, you should be 100% stocks. But then your emergency fund has to be twice the size just in case stocks drop by 50%. The article basically says to do something similar: stocks plus a larger emergency fund.


Indeed, it seems that all the article suggests is messing a bit with the distinction of "emergency fund" and "investment portfolio". Not much else to see there. Somewhat disappointing, given that the author "lectures at New York University, London Business School, and the London School of Economics on the topic" (although one's google skills need to be much better than mine to find what he actually might be teaching at any of these places).
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby livesoft » Sun Sep 01, 2013 8:31 pm

"... lectures at ..." just means he stood outside the places on a street corner and told his friend, "Hey, emergency funds should be invested."
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby Rob5TCP » Sun Sep 01, 2013 8:37 pm

Here is the best I could find about him

Dan Egan, Director of Behavioral Finance and Investing at Betterment. Mr Egan was Formerly at Barclay's Wealth and Investment where he focused on using behavioral finance to help people make better financial decisions. His presentation will focus on the impact of how we visualize risk and return.

No mention of where he got his degree, what degree, and so on.

He did author this presentation for Barclay wealth management on behavior in science
(ie panicking and selling at the bottom and so on).

http://www.cisi.org/BOOKMARK/WEB9/COMMO ... 250111.PDF

I think I will stick with Rick, Larry, Mr. Bernstein, Taylor, Mel and others.
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby Vanner » Sun Sep 01, 2013 8:53 pm

I kinda like this idea. My job and my wife's are pretty secure, and I think my chance of needing my emergency fund is lower than the average person's. So what if I wanted to begin investing this extra 10 grand. Could I put it in a ROth IRA and withdraw the money at a moments notice if I needed to? I don't know how Roths work... Would there be a penalty for doing so?

What kind of investments are there that you could withdraw without penalty?
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby Texas hold em71 » Sun Sep 01, 2013 8:56 pm

Vanner wrote:I kinda like this idea. My job and my wife's are pretty secure, and I think my chance of needing my emergency fund is lower than the average person's. So what if I wanted to begin investing this extra 10 grand. Could I put it in a ROth IRA and withdraw the money at a moments notice if I needed to? I don't know how Roths work... Would there be a penalty for doing so? yes on the earnings but there a few exceptions for things like disability and very high medical expenses

What kind of investments are there that you could withdraw without penalty?


savings accounts are th most obvious.
Last edited by Texas hold em71 on Sun Sep 01, 2013 9:58 pm, edited 1 time in total.
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby lindisfarne » Sun Sep 01, 2013 9:57 pm

Vanner wrote:I kinda like this idea. My job and my wife's are pretty secure, and I think my chance of needing my emergency fund is lower than the average person's. So what if I wanted to begin investing this extra 10 grand. Could I put it in a ROth IRA and withdraw the money at a moments notice if I needed to? I don't know how Roths work... Would there be a penalty for doing so?

What kind of investments are there that you could withdraw without penalty?


There have been other discussions on this board about using a Roth IRA as an emergency fund. At least some people see it as ok. If you are fairly secure in your income, I don't think it's all that bad of an idea, especially if you have a good amount of money put away for retirement (or if you are young). Yes, it's a risk - if you need the money right after the market tanks, it's not great, but if the amount in the Roth increases by 50% before you need it, it will seem like a good idea compared to a savings account rate of .5%.
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby Phineas J. Whoopee » Mon Sep 02, 2013 12:28 pm

A Boglehead-wiki approach is placing cash needs in a tax-advantaged account.

It does require a 100% safety factor in taxable, but none in tax-deferred rather than the 30% Betterment uses. Taken over time, that should be a good thing on average.

PJW
[Mildly edited as to fixing my words; strongly edited as to fixing my meaning.]
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby nedsaid » Mon Sep 02, 2013 12:49 pm

This is just an investment pitch. Don't like what is on the hook and I won't bite.

A safety net needs to be safe. Interest rates are extremely low and I have dealt with this by buying I-Bonds at Treasury Direct. These are illiquid for a year, but after a year are an excellent place for emergency cash.
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby plymster » Mon Sep 02, 2013 1:29 pm

This just seems like extra-ordinarily bad advice at best. Just looking at their "Invested safety net fund over every five-year period, starting 1955" chart, there are times when your "safety net" +30% is badly compromised. And I have to agree with other posters that it forces you to sell assets at EXACTLY the wrong time.

It's ironic that Egan's newer article is "Overconfidence Hurts Results: Lessons From The Pool".
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby stemikger » Mon Sep 02, 2013 1:37 pm

Rob5TCP wrote:They seem to assume you won't need your safety net 3-6 months after you set it up. Had this been 2008 and you lost your job in a bad econmoy, you don't want a safety net that has just been reduced by half. Plus you might be forced to liquidate at just the worst time.

True, if you don't need it for 5, 10, 20 years, it would be better in equities. But, you have no idea idea whether you will need it in 25 years / months / or even weeks. For that reason, I would keep it as safe as possible. Take risk on other, longer term investments, that you can comfortable ride out market swings.


+1

A safety net is not an investment, it's insurance. No one knows if or when they are going to need it, but it is necessary for protection. After the smoke clears, who knows how much you will earn. I agree with Rob5TCP take risk elsewhere.
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby IlliniDave » Mon Sep 02, 2013 1:52 pm

It's partly a question of semantics and partly a question of total wealth.

From a semantics perspective, in a deep enough emergency even invested retirement assets come onto the table.

From a relative wealth perspective, for someone in a humble financial position with uncertain future prospects (a 50 year old hourly wage earner with, say, $50K in total financial assets), any volatility in the emergency fund seems unwise. For someone with financial assets an order of magnitude or more higher, pointing to a portion of the investments and declaring them an emergency fund is probably okay if it suits the person's temperament.
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby Rick Ferri » Mon Sep 02, 2013 1:52 pm

Rob5TCP wrote:Here is the best I could find about him

Dan Egan, Director of Behavioral Finance and Investing at Betterment. Mr Egan was Formerly at Barclay's Wealth and Investment where he focused on using behavioral finance to help people make better financial decisions. His presentation will focus on the impact of how we visualize risk and return.

No mention of where he got his degree, what degree, and so on.


I meet Dan a couple of months ago in New York. I enjoyed our brief conversation. He is an interesting guy and clearly well-educated.

My view on emergency money parallels the way a corporate finance department would look at it (I used to teach corporate finance at a local college). I see the need to divide emergency funds into two parts: "immediate" liquid assets that are held in cash like investments and "permanent" liquid assets that can be invested more aggressively.

There are times I've dipped into my emergency savings, but I never depleted them, and always brought the total back up to my 12-month living expense target. I realized that I rarely dipped into our emergency money, and if I held only half of this money in very liquid cash assets that is was probably enough.

Starting about 5-years ago, I split the permanent liquid asset half of my emergency fund into an intermediate-term municipal bond fund and total stock market index fund. My idea was to be more aggressive with these permanent liquid assets so that my total emergency fund would have the chance to outperform inflation and taxes. That has happened.

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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby nisiprius » Mon Sep 02, 2013 3:00 pm

As I noted in another thread, this paper forfeits all claim to serious consideration by its unexplained choice of data. The only actual data they use on "income and expense shocks" is the specific shock of job loss. For that shock, they use only unemployment data from 1948 to 2011. No reason for that choice is given. It is not simply data availability, since BLS data back to 1940 is available--Employment status of the civilian noninstitutional population, 1940 to date--and estimates back to 1890 are available:

Image

Obviously, if you eliminate from consideration the Great Depression and the Long Depression, you will come to the conclusion that job loss "Emergencies may not happen as frequently as imagined." Equally obviously, one ought to be considering, not just the frequency of emergencies, but their magnitude and consequences.
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby momar » Mon Sep 02, 2013 3:18 pm

lindisfarne wrote:
Vanner wrote:I kinda like this idea. My job and my wife's are pretty secure, and I think my chance of needing my emergency fund is lower than the average person's. So what if I wanted to begin investing this extra 10 grand. Could I put it in a ROth IRA and withdraw the money at a moments notice if I needed to? I don't know how Roths work... Would there be a penalty for doing so?

What kind of investments are there that you could withdraw without penalty?


There have been other discussions on this board about using a Roth IRA as an emergency fund. At least some people see it as ok. If you are fairly secure in your income, I don't think it's all that bad of an idea, especially if you have a good amount of money put away for retirement (or if you are young). Yes, it's a risk - if you need the money right after the market tanks, it's not great, but if the amount in the Roth increases by 50% before you need it, it will seem like a good idea compared to a savings account rate of .5%.

Using a Roth IRA as your emergency fund is a separate issue from whether to invest your emergency fund in risky assets. Most often when people recommend using the Roth IRA as an emergency fund, they are advocating using low risk investments like a savings account, CD, or short term bond fund.

You can withdraw Roth IRA contributions without penalty.
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Re: Safety Net Funds, why Traditional Advice is Wrong.

Postby digit8 » Mon Sep 02, 2013 5:52 pm

Meh. Once I had my basic EF in the bank, I started putting a little here and there into a taxable index fund as some extra cushion, and it is nice to see that bit earning some decent returns over time.

But when disasters have hit(or even seem likely) it's always that safe, boring pile earning me doodly-squat that actually keeps me calm and sleeping well.
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