How small can I make my emergency fund?

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How small can I make my emergency fund?

Post by Wealth_Builder » Sat Apr 07, 2018 7:21 pm

How small can I make my emergency fund?

Age: 27
Marital Status: Single
Employment: Great job, high income (unlikely to be laid off and employer would probably provide 3-5 months severance pay if it happened)
Debt: House mortgage ONLY (I rent out 3 extra room though, so this covers my entire costs) Worst case would be ~2,000 for all house-related expenses.
Credit Limit: $85k+ (I never carry a balance past it's due date)
Monthly out-of-pocket Expenses: $1,500-2,000 (employer pays for many meals, insurance, cell phone)
After-tax Investment Account: $100k

I've debated and heard the wisdom of 3-6 months of expenses, but wouldn't mind taking this a bit more aggressive. Does available credit ever count towards an emergency fund? Due to previous work travel with reimbursable expenses, I have a large credit limit.

Since I'm still young, I'm probably a bit ignorant of the downsides I don't see. What's all the bad things that could happen that would make me wish I'd have carried a larger emergency fund?

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Re: How small can I make my emergency fund?

Post by mhalley » Sat Apr 07, 2018 7:26 pm

It would probably take a series of unfortunate events to make an emergency fund truly needed. Usually something simple like the hvac dies can be taken care of by using your credit cards. But if something truly catastrophic happens you will be glad you have it.
So here is an example: a freak storm demolishes your house, and insurance denies the claim as it is flood damage and you have no flood insurance You have to live somewhere else while still having the large mortgage payment. Your car was also destroyed and you need to buy a new one. You are cleaning the debris from the ravaged site and you fall and break your leg, which causes you to be unable to work for a prolonged period of time, just after you got laid off.
Last edited by mhalley on Sat Apr 07, 2018 7:31 pm, edited 2 times in total.

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Re: How small can I make my emergency fund?

Post by FiveK » Sat Apr 07, 2018 7:29 pm

Wealth_Builder wrote:
Sat Apr 07, 2018 7:21 pm
What's all the bad things that could happen that would make me wish I'd have carried a larger emergency fund?
Can't list 'em all, but a common worst case trifecta is "loss of job due to injury that causes huge medical bills while still liable for a large monthly mortgage payment."

Given your situation, you may be able to sleep well with a lower e-fund than many, but it's really a guess in any case.

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Re: How small can I make my emergency fund?

Post by TinkerPDX » Sat Apr 07, 2018 7:34 pm

Many are comfortable considering a Roth account as part of the emergency fund, since at least part of it is accessible in an emergency without penalties, as long as you have enough of it in relatively low-risk investments. I consider our Roth accounts as part of the EF.

I also consider my treasury direct account where I hold I- and EE-bonds and also some TIPS and regular bonds, both as a part of my overall retirement AA and as part of my EF.

The idea of holding any cash as pure EF is probably unnecessary for you; though if you want to be really aggressive with a low EF, you may want a slightly less aggressive overall AA (or at least enough to make sure portfolio * bond % = big enough EF).

While you're probably right that you won't get laid off and that you'd get a little severance, the point of an EF is to be prepared for the unexpected. Putting six months' expenses on credit cards seems like a bad move. Your expenses are low enough that having 3-6 months in bond allocation shouldn't feel too painful.

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Re: How small can I make my emergency fund?

Post by Nate79 » Sat Apr 07, 2018 7:38 pm

I would hold 3 months of expenses in cash/high yield savings/treasuries/etc where you have to cover all expenses - no rental income and you lose your job. Worst case of great depression like economic drop with stocks falling 85% and prolonged down period. In that case your stocks would only cover a couple of months of expenses. I always discount stocks 85% to include them in an emergency fund.

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Re: How small can I make my emergency fund?

Post by mortfree » Sat Apr 07, 2018 7:46 pm

<<After tax investments of 100k>>

That’s your tier 3 EF

Tier 1 is the cash
Tier 2 is credit card (temporary until you pool cash or sell investments).

So Tier 1 could be whatever amount you want. So long as you are comfortable liquidating taxable even if market is down significantly and you need to sell.

I think you should be around 5-10k for an aggressive approach.

My conservative nature has me with 40k savings.

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Re: How small can I make my emergency fund?

Post by Clever_Username » Sat Apr 07, 2018 8:12 pm

It isn't so much an emergency fund that's important as an emergency plan. What would you do if the above mentioned trifecta happened? What if just a subset?

I have three months' expenses in cash (between checking, savings, and MM at Vanguard). That's probably too much. I will probably reduce it to two months' expenses later this year (and not by increasing expenses).

I also have almost eight months' expenses in Series I Bonds that are over a year old, several more months' expenses in Roth IRA contributions, over half a year's expenses in a bond fund in taxable, and so on. The items I listed in this paragraph are part of my allocation. They aren't money I expect to touch until I retire (I might use some of the taxable bond fund towards a car, depending on financing options, when the time comes, which is likely years off anyway). But they're part of my emergency plan, if I'm unemployed for a while, which I doubt will happen willingly short of a major injury. They're part of my emergency plan, not a designated bucket of money.

3-6 months expenses as an emergency fund in cash is nice advice for someone young before they can really have a plan other than "get at the cash." A taxable allocation for them is too volatile to be the only tier of the plan. Their Series I Bonds, if any, probably haven't hit the one year mark yet. They likely haven't made many Roth IRA contributions.

In short, a young person isn't in a situation where there is a suitable investment for what we think of as "emergency funds" other than cash. Telling people to keep it in cash prevents it from going into inappropriate investments.

So, to answer your question finally : what would you like your plan to be? If you lose your job, how do you hold over until unemployment or new employment kicks in? Are you even eligible for unemployment? If you don't know, find out. I found out I'm not eligible, but fortunately didn't find out at a time I needed it.
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_

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Re: How small can I make my emergency fund?

Post by MoneyMarathon » Sat Apr 07, 2018 8:36 pm

Wealth_Builder wrote:
Sat Apr 07, 2018 7:21 pm
How small can I make my emergency fund?
$0. You just need to have a well-considered contingency plan. Something has to back up your sudden credit card spending. Assuming that you don't have severance (might not be job loss, or job loss is extended beyond it), figure out where the money would come from. The goal is to avoid:

1) Paying the 10%+ interest on the cards.
2) Paying a 50%+ loss "locked in" by pulling from equities (opportunity cost if it grows again), in a bear market.

One option is I-bonds. Doesn't increase tax liability (tax-deferred), principal protected, inflation-linked. Liquidity after 1 year.

Another option is to buy a 20% stock / 80% bond fund and make it 10% larger than you otherwise would (surprisingly, it works just as well, if not better - except for the tax implications, relative to I-bonds). You could buy 80% munis if the taxes are a problem.

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Re: How small can I make my emergency fund?

Post by quantAndHold » Sat Apr 07, 2018 8:56 pm

Do you have disability insurance? Being unable to work at the same time that you have large medical expenses is a financial killer.

The other thing I would worry about in your situation is that your job is not as stable as you think it is. In 2002, I woke up one morning, and the awesome, stable tech company I worked for had filed for bankruptcy, and all of the C level guys had been indicted for securities fraud. Thy had been cooking the books for years, and it became apparent when the economy went south. The stock went from $25 to $0.25 that day, and over half the company got laid off with no severance later that month. This was the middle of the dotcom bust, so at the same time, the stock market was grinding relentlessly downward, and new jobs were scarce. Friends lost their homes and had to start over. One guy I knew owned a house and was renting rooms to a bunch of coworkers, who all got laid off and couldn’t pay rent.

You might not actually need a huge emergency fund. But you might want to make sure that you don’t have a lot of concentrated risk on one company, no matter how awesome that company is. If your stock portfolio is concentrated in the company you get most of your income from, and you rent rooms to people who work at that company too, you might want to make some adjustments.

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