SpecialK22 wrote:How do you other bogleheads determine the appropriate size of your emergency fund? The 3-12 months living expenses is fairly vague, and I'm sure people have different definitions of what constitutes and emergency.
SpecialK22 wrote:Thanks for the insight, neverknow. I was never advocating not having liquid assets in reserve for an emergency, but instead was wondering how individuals determine the size. It seems the "rule of thumb" advice ranges anywhere from 3 to 12 months living expenses. Why? Unemployment benefits, health insurance, severance packages, short and long term disability insurance etc. can help smooth over certain emergencies, at least for a short while. These all lessen the amount of money needed in reserves in order to maintain a lifestyle in a number of emergency situations. Obviously, there are black swans, but many emergency type situations wouldn't leave you with only your emergency fund to pay for them or to maintain a reasonable quality of life.
I guess my question is this: When does the premium on liquidity become too much? All my cash is in accounts earning much less than 5.00%, which is what my fixed mortgage rate is at. In essence, I am losing money by not paying down the debt and instead keeping cash or cash equivalents on hand. It is absolutely necessary to have some liquidity, but I think this can go too far. How do you all factor in different insurances, government benefits, severance packages, etc. in determining the size of a liquid emergency fund? I know these questions are very specific to individual situations, but I'm still interested in others' opinions. For someone who wants six months of living expenses in cash, why? That is not to say there is anything wrong with it, just wondering how they arrived at that number. More pointedly, why do you feel you need that much in cash reserves rather than paying down debt or more aggressively investing? What's the point of insurance if you have enough assets on hand to cover the precise situation you are insuring?
Sorry for the fairly long post, I'm just wondering why and how other bogleheads arrived at the decision to keep X months of living expenses in cash, particularly if they have debt. Maybe it's just a feel good number? Maybe others would rather keep a pile of cash on hand to cover emergencies rather than have insurance, or maybe keep insurance premiums cheaper by having a higher deductible or catastrophic limit? How does the cash on hand play into the overall game plan for emergencies that you could see happening? When does it become too costly to keep debt outstanding in the name of liquidity? Why do I overanalyze things?
sscritic wrote: I don't have a car fund, a vacation fund, and an emergency fund, all segregated and invested separately using different investment strategies. It's all just money to me.
You don't have to use cash for liquidity - what about Limited or Intermediate Term Tax-Exempt Bond funds? For me, IT tax exempt yields more than the after-tax cost of my mortgage, so there is no "liquidity insurance premium" for using that to hold funds that could otherwise go to my mortgage. In fact I earn more using IT than I would save in interest if I paid off my mortgage. If I were to step it down to Limited Term to get less NAV volatility, then it would cost me about $1850 per year (the after tax difference between the bond distribution and mortgage interest cost), which to me is a fair price for a liquidity insurance premium.
Mortgage = ~200k
Mortgage interest carrying cost after tax = ~6300
200k invested in Ltd TE yields ~ 4450 after tax
200k invested in IT TE yields ~ 7050 after tax
To me liquidity is more important than some "emotional" value of having no leverage in my capital structure. Net worth is all that matters to me. And I can't eat my house.
Side note: I do keep about 25k lying around in cash. But above that, I save using TE bond funds, and this savings is distinct from my investment portfolio.
SpecialK22 wrote:mike_slc wrote:
Aren't you unable to deduct mortgage interest if you hold sufficient funds within TE bonds which could pay off the mortgage? Aside from that, TE bonds aren't a bad idea as a portion of an emergency fund. They do still carry more risk than cash, which is why I prefer my emergency fund to be cash. I suppose I could set up some sort of tier system.
And yes, I realize I cannot eat my house; however, a paid off mortgage would significantly reduce my cash outflow obligations which would be extremely useful if cash inflows were drastically reduced. I do see the risk of putting extra towards the mortgage and not having it paid off fully by the time a major emergency hits. In that situation, I would still be required to make the normal monthly payment, although more of the payment would be going to reduce the prinicpal. "Emotional" aspects do come into play, but I also feel that it is smart, albeit conservative, financial move to pay down the mortgage, at least in the current interest rate enviornment. For the time being, interest on CDs and savings accounts won't beat it. Also, limited term or intermediate term muni's may beat it, but they also assume a greater risk.
1. There is no rule limiting tax deduction of a mortgage based on how much you have in TE bonds.
CMMCC wrote:2. You have way more liquidity (200k more) by having 200k in TE bonds and a 200k mortgage VS no mortgage and no TE bonds. Your cash flow is better with no mortgage, but you can go a long time with 200k in liquidity.
Dan Moroboshi wrote:Here's a somewhat related thread on the topic of maintaining an emergency fund here:
I keep three months of living expenses in FDIC/NCUA insured bank savings (Split between a bank and a credit union - unlikely that both will go under simultaneously.) Low interest rate, but accessible immediately from an ATM whenever needed. This also serves as a cushion for if the water heater blows up, the basement floods, etc. If tapped, the reserve is replenished as soon as possible.
I have disability insurance that would kick in if I were unable to work for longer than three months, hence the three month reserve.
I keep six months of living expenses in a money market mutual fund at Vanguard - slightly higher yield than the bank accounts, at the cost of not having same-day access, and no FDIC insurance. I don't use short-term bond funds for this purpose, because I value stability of principal over yield for the emergency fund. I would use this reserve for a situation in which I would have no income for a protracted period, which would not be covered by my disability insurance. (I deem this the "my office was destroyed by a fire/tornado/earthquake/meteorite" fund, or the "f**k you, I quit" fund.)
By the way, "X month's expenses" = the amount required to maintain my current standard of living. In a pinch, I could scale back spending and stretch out the funds to last well over a year.
I concede that the size of my fund (9+ months of living expenses) is probably excessive. However, I'm pessimistic, and prefer to prepare for the worst.
Of course, there are scenarios in which the fund would probably not suffice - for example, if my wife or one of the kids got cancer or some other dire condition, and I decided to quit working while racking up medical expenses as we travelled to specialty centers in a desperate attempt to find an experimental treatment...
But in that case, I'd liquidate long-term holdings in my taxable portfolio as needed.
SpecialK22 wrote:Thanks for the breakdown, Dan. It's a similar concept to how I am trying to structure my emergency fund. It seems like there is insurance or some sort of benefits that help to smooth out most of the typical emergency situations I might face. Lately I've been thinking I have too much in cash at the expense of investing in more aggressive asset classes or paying down the mortgage quicker. I also agree that there are certain emergencies, many unseen, which I might never be prepared for.
Looking at the link you provided, I now remember seeing that a short time ago. I still feel an emergency fund/cash reserves are necessary, I just feel that I may be overdoing it relative to "likely" emergencies. Maybe the best advice is what some of you have already said: "have enough so you can sleep comfortably at night."
TxAg wrote:I'm probably over simplifying it, but I just add up my take-home pay for the month and multiply by 6. That gives me at least a 6 month cushion living my life exactly as I live it now. If times were really tough, I could cut out a lot of expenses and get at least 9 months. I'm a single guy with no kids and no mortgage so, again, it's over simplified in my example.
caluchko wrote:Hey Dan,
If there is an "emergency of epic proportions", what makes you think people will accept cash? Better to buy ammo and canned food. Better yet, better to buy a place in the country will an off-grid electricity supply and some land to farm.
But seriously, do a lot of you guys really leave like thousands of dollars in cash around the house in case of an epic emergency? Could this be a case of perceived risk being greater than actual risk? Then again, my wife's parents are form the former Soviet Union and will not put a dime in the bank because they lost their entire savings in 1991 when the USSR collapsed. I fel differently if that happened to me.
As a retired person with adequate savings and a steady income from social security and pensions, my emergency fund is zero. That's not to say that I don't have CDs and a money fund, but that I don't segregate this money as having one purpose from that money as having another purpose in my mind. All my money is to support me during my life and to go to my children after I die. I don't have a car fund, a vacation fund, and an emergency fund, all segregated and invested separately using different investment strategies. It's all just money to me.
Here's an article to ponder The $0 Emergency Fund.
My emergency fund = 3 years.
1) I am above 40 years old. In this industry, age discrimination is common.
2) My industry laid off 1 1/2 millions people over the last few years. And, as your phone call get cheaper, there will be more laid off.
3) So, if I lose my job now, there is a good chance that I will be forced into early retirement or permanently under-employed.
Here's an article to ponder The $0 Emergency Fund.
spam wrote:boris wrote:Here's an article to ponder The $0 Emergency Fund.
In my opinion, liz weston is a fool. She advocates living paycheck to paycheck while taking equity risk which is financed by reducing credit card debt.
Next she says ... well if you need money for an emergency, then use your credit card. A woman like that would quickly bankrupt any well-to-do husband. She would see the "inappropriately large savings account" and ..... SPEND IT. Wow, what a relief.
spam wrote:I have easily done what she claims is impossible to do. My credit card balance is less than $800 and paid off every month, I have no personal loans, I have a large emergency fund, I have a large retirement account with no home mortgage. With a wife like her, I would have nothing.
spam wrote:Oh .... poor lizzzy wails, you will not be able to establish your emergency fund instantly or even over the weekend .... (sob sob sob)
good grief. talk about financial porn. The point, deer lizzzy, is that it does take time. It also takes a plan and some discipline.
Boris wrote:spam wrote:boris wrote:
You may consider her a fool, but I think she makes great points. In the example you described, she may advocate paying off your credit card debt prior to getting an emergency fund. Why? Because by the time you accumulate for an emergency fund your CC bills will kill you. Just pay off the CC instead and in case of an emergency you can always use your CC again. It makes perfect sense.
An emergency fund is just for that: emergencies. Emergencies don't happen often, so why dedicate money to them if you can always tap something in case they happen?
Again, her advice isn't meant for someone like you. It's meant for someone who's starting out and/or may not have a lot in terms of cash flow and has debt. A "typical" American scenario.
Which lines in her article did you dislike, specifically?