Is an emergency just mental accounting?

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H-Town
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Re: Is an emergency just mental accounting?

Post by H-Town » Tue May 21, 2019 1:47 pm

Old_Dollar wrote:
Mon May 20, 2019 6:52 pm
In the case of an emergency fund the special "money jar" is often a high-yield savings account, money market account, etc.

Is there any reason why someone shouldn't just revisit their risk tolerance and redirect the emergency fund to that allocation in a brokerage account? For example, a portfolio that is 80/20 with an emergency fund in a money market account becomes a 75/25 portfolio with the emergency fund fully invested in the portfolio.
Then you're just making AA ratio an arbitrary number. What's the difference between 80/20 and 75/25 to your personal situation?

Start with your goal and your personal situation. Then see if it calls for a 2 year of living expenses set aside in cash or cash equivalent?
- For most people who have sizable taxable brokerage account, they can get the money whenever they need it.
- For most of those people in this group, they can also cash flow unexpected expenses (unless it's a huge bill).
- And if they have stable job, the need for 2 year of living expenses during their accumulation phase is non-existence.

In the grand scheme, the lost of opportunity cost for EF is immaterial. So whether you do have EF or you don't, it just doesn't matter much.

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nisiprius
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Re: Is an emergency just mental accounting?

Post by nisiprius » Tue May 21, 2019 2:02 pm

Lee_WSP wrote:
Tue May 21, 2019 1:37 pm
...I'm for the latter because the FDIC account is there for true liquidity and the rest of the fund can be earning interest rather than sitting around in a vault...
Money in a bank is earning interest and is not "sitting around in a vault." I think the investment industry tries to motivate people to take risk by intentionally confusing the ideas of "cash" in the sense of paper currency with a number of dollars printed on it, and "cash" in the sense of a competitively-yielding bank account. Bank accounts have typically have had yields broadly comparable to Treasury bills, and thus typically have eked out a microscopic but positive real return.

Money in the bank is not just "sitting around in a vault" and, if you've been reasonably shrewd about choosing your account, is not usually being decimated by inflation. Mind you, I'm talking about a normal bank account, not bundles of $100 bills in a safe deposit box. That would, of course, be just "sitting around in the vault."
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Lee_WSP
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Re: Is an emergency just mental accounting?

Post by Lee_WSP » Tue May 21, 2019 2:30 pm

nisiprius wrote:
Tue May 21, 2019 2:02 pm
Lee_WSP wrote:
Tue May 21, 2019 1:37 pm
...I'm for the latter because the FDIC account is there for true liquidity and the rest of the fund can be earning interest rather than sitting around in a vault...
Money in a bank is earning interest and is not "sitting around in a vault." I think the investment industry tries to motivate people to take risk by intentionally confusing the ideas of "cash" in the sense of paper currency with a number of dollars printed on it, and "cash" in the sense of a competitively-yielding bank account. Bank accounts have typically have had yields broadly comparable to Treasury bills, and thus typically have eked out a microscopic but positive real return.

Money in the bank is not just "sitting around in a vault" and, if you've been reasonably shrewd about choosing your account, is not usually being decimated by inflation. Mind you, I'm talking about a normal bank account, not bundles of $100 bills in a safe deposit box. That would, of course, be just "sitting around in the vault."
I was just being facetious. But some savings accounts, maybe even most, aren't earning even a full percentage point, so really it's not that different from sitting around in a vault. This can change, but that's the current landscape with savings accounts.

Edit : it's even worse than I thought. Boa is not even five basis points. 0.03% interest rate on savings.

Point
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Re: Is an emergency just mental accounting?

Post by Point » Tue May 21, 2019 2:38 pm

Yes it is mental accounting.

It’s important to use friction to your advantage and that’s what calling these funds “emergency” does. Many times we see money as fungible, to our own detriment. Categorizing these as emergency both helps us realize that we must anticipate, size, and allocate for the extreme unexpected. At the same time it provides friction, keeping us from easily wanted by to use these available funds for some other “want.”

JackoC
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Re: Is an emergency just mental accounting?

Post by JackoC » Tue May 21, 2019 3:32 pm

RickBoglehead wrote:
Mon May 20, 2019 9:05 pm
Grogs wrote:
Mon May 20, 2019 8:09 pm

Yes, the average American doesn't have an after-tax brokerage account.
Says who?
This study gave figures from 2013 saying around 12% of US households had a brokerage account which was not limited to IRA assets, table at the bottom of the first full page after intro and table of contents. Seems very non-shocking to me. An alternative well known figure by Gallup suggests a similar situation: that 54% of Americans are 'invested in the stock market' but that includes not only 401k's held at companies but people who are future beneficiaries of Defined Contribution pension plans invested in the stock market. Households below the median income are unlikely to have assets other than bank accounts, personal property and home equity and many have little of the first two and none of the third.
https://www.dol.gov/sites/default/files ... the-us.pdf

On people giving asset allocations that omit major assets, like cash balances that might be significant, or home equity, that's confusing. When people here say they are X% stock I wonder what they aren't counting and seldom take it literally. But, I suppose, why should they care if I don't understand their actual financial situation? As long as they do. And since there is some bragging factor I think quoting a high stock allocation, it's probably good if people's allocations are really lower than the reckless levels of stock exposure (just IMHO) sometimes quoted here.

22twain
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Re: Is an emergency just mental accounting?

Post by 22twain » Tue May 21, 2019 3:40 pm

mikeyzito22 wrote:
Mon May 20, 2019 9:39 pm
RickBoglehead wrote:
Mon May 20, 2019 9:05 pm
Grogs wrote:
Mon May 20, 2019 8:09 pm
Yes, the average American doesn't have an after-tax brokerage account.
Says who?
The average AGI (adjusted) in Oregon is $57,000 and Portland is HCOL. How then is it possible to max out all retirement vehicles? We make more than that and I still couldn't max out everything.
We're in a southeastern state where the average income is surely lower. My salary as a small-town small-college professor maxed out at about $65K in today's dollars. DW's situation was similar. I recently looked up household income statistics for our county. We were in the top 5-10%.

For most of our careers, all our savings were either in our 403(b) plans at work (and therefore basically unavailable for near-term expenses), or in bank checking and savings accounts. The latter were for possible real emergencies as well as for lumpy large expenses such as vacations, new cars or a new roof. We didn't have an account specifically designated as "emergency fund." We simply made sure to keep "enough" in the bank accounts.

I didn't max out my 403(b) (including the over-50 catchup contributions) until my 50s. About that time, I received an inheritance and used it to set up an after-tax mutual-fund account, then a brokerage account using ETFs.
My investing princiPLEs do not include absolutely preserving princiPAL.

Lee_WSP
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Re: Is an emergency just mental accounting?

Post by Lee_WSP » Tue May 21, 2019 4:07 pm

mikeyzito22 wrote:
Mon May 20, 2019 9:39 pm
The average AGI (adjusted) in Oregon is $57,000 and Portland is HCOL. How then is it possible to max out all retirement vehicles? We make more than that and I still couldn't max out everything. I'm working on maxing Roth's, but seriously....most of my friends and even folks older than I don't have a taxable account. Actually I know some very wealthy individuals that can max out those accounts and that's it. I often wonder if Bogleheads is just for conservative rich folks. I love this forum. I guess I'll see in time.
It's very possible off of $57,000. Less feasible, but still possible with children.

$57,000 - $25,500 = $31,500

By taking the tax deferrments instead of doing the ROTH, taking the full deduction makes you eligible for ACA healthcare subsidies. Or you can do without.

No car payment or taking the bus would eliminate a huge budget line item.

Having a roommate would enable you to have housing at or under $1k/mo.

That still leaves ~$11k in money to allocate to other expenses or ~$900/month for food and entertainment and whatnot.


But the final part of your post is kind of a self fulfilling statement. Bogleheads is a self selected group of people. By definition, we're all about either maximizing our savings rate or we're wealthy/high income. If neither of those two conditions was met, I don't see the appeal of Bogleheads to such a person.

TheMadEph
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Re: Is an emergency just mental accounting?

Post by TheMadEph » Tue May 21, 2019 5:02 pm

22twain wrote:
Tue May 21, 2019 3:40 pm
mikeyzito22 wrote:
Mon May 20, 2019 9:39 pm
RickBoglehead wrote:
Mon May 20, 2019 9:05 pm
Grogs wrote:
Mon May 20, 2019 8:09 pm
Yes, the average American doesn't have an after-tax brokerage account.
Says who?
The average AGI (adjusted) in Oregon is $57,000 and Portland is HCOL. How then is it possible to max out all retirement vehicles? We make more than that and I still couldn't max out everything.
We're in a southeastern state where the average income is surely lower. My salary as a small-town small-college professor maxed out at about $65K in today's dollars. DW's situation was similar. I recently looked up household income statistics for our county. We were in the top 5-10%.

For most of our careers, all our savings were either in our 403(b) plans at work (and therefore basically unavailable for near-term expenses), or in bank checking and savings accounts. The latter were for possible real emergencies as well as for lumpy large expenses such as vacations, new cars or a new roof. We didn't have an account specifically designated as "emergency fund." We simply made sure to keep "enough" in the bank accounts.

I didn't max out my 403(b) (including the over-50 catchup contributions) until my 50s. About that time, I received an inheritance and used it to set up an after-tax mutual-fund account, then a brokerage account using ETFs.
Maybe RickBoglehead can enlighten us why he thinks that a statement such as "the average american doesn't have an after tax brokerage account" is some sort of crazy claim that demands detailed substantiation (which, from my perspective was already addressed above in any event).
Seems like an odd claim to demand attribution/sources for. Is there some bit of contrary evidence that Rick has that would lead him to question that claim? Otherwise it seems like an odd fight to pick. It is as if I said "the average american doesn't fly business class" and someone says "oh yeah? I'll only believe that if you show me a study proving that".

venkman
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Re: Is an emergency just mental accounting?

Post by venkman » Tue May 21, 2019 10:33 pm

stan1 wrote:
Tue May 21, 2019 9:16 am
Actually the first purpose of an emergency fund is to avoid borrowing money and then having to pay interest on money needed for a car repair, home repair, or unplanned trip for a funeral. That's not mental accounting.

However, if you have the cash flow and liquidity through income and assets to pay for those expenses without needing to borrow money it does increasingly become "mental accounting" and you may not need an emergency fund. Very different situation than taking on credit card debt.
But if the "emergency" is losing your job, you might not have the cash flow to pay even normal expenses. And job loss is more likely during a recession, when stocks will almost certainly be down (though obviously some jobs are more recession-proof than others).

22twain
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Re: Is an emergency just mental accounting?

Post by 22twain » Wed May 22, 2019 6:46 am

venkman wrote:
Tue May 21, 2019 10:33 pm
And job loss is more likely during a recession, when stocks will almost certainly be down
"Bonds, James. Bonds."
My investing princiPLEs do not include absolutely preserving princiPAL.

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Re: Is an emergency just mental accounting?

Post by stan1 » Wed May 22, 2019 7:13 am

venkman wrote:
Tue May 21, 2019 10:33 pm
stan1 wrote:
Tue May 21, 2019 9:16 am
Actually the first purpose of an emergency fund is to avoid borrowing money and then having to pay interest on money needed for a car repair, home repair, or unplanned trip for a funeral. That's not mental accounting.

However, if you have the cash flow and liquidity through income and assets to pay for those expenses without needing to borrow money it does increasingly become "mental accounting" and you may not need an emergency fund. Very different situation than taking on credit card debt.
But if the "emergency" is losing your job, you might not have the cash flow to pay even normal expenses. And job loss is more likely during a recession, when stocks will almost certainly be down (though obviously some jobs are more recession-proof than others).
Right, likelihood and consequence are part of a risk assessment. If job loss is a medium to high likelihood during a recession yes you'd want to plan differently than someone who has a low or very low likelihood of job loss. If you and your spouse both have cyclical jobs and you've chosen a 100% equity portfolio agree some cash in an emergency fund is a good idea so you don't have to borrow. However if you have a 50/50 equity/bond portfolio and you have one secure job with one cyclical job and you have $100K+ in a muni bond fund maybe you may decide its an acceptable level of risk to carry less cash since you have multiple ways to avoid borrowing. If you have large taxable and tax advantaged balances you can sell equities in taxable and rebalance bonds back into equities in tax deferred, too. You could also just take a conservative position that you want a lot of cash just in case. That's a choice some people make but it does come at a cost. No right or wrong answer.

venkman
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Re: Is an emergency just mental accounting?

Post by venkman » Wed May 22, 2019 11:11 pm

stan1 wrote:
Wed May 22, 2019 7:13 am
Right, likelihood and consequence are part of a risk assessment. If job loss is a medium to high likelihood during a recession yes you'd want to plan differently than someone who has a low or very low likelihood of job loss. If you and your spouse both have cyclical jobs and you've chosen a 100% equity portfolio agree some cash in an emergency fund is a good idea so you don't have to borrow. However if you have a 50/50 equity/bond portfolio and you have one secure job with one cyclical job and you have $100K+ in a muni bond fund maybe you may decide its an acceptable level of risk to carry less cash since you have multiple ways to avoid borrowing. If you have large taxable and tax advantaged balances you can sell equities in taxable and rebalance bonds back into equities in tax deferred, too. You could also just take a conservative position that you want a lot of cash just in case. That's a choice some people make but it does come at a cost. No right or wrong answer.
I agree that, if your portfolio is large enough that the amount of your emergency fund would not have an appreciable effect on your AA, you don't need an emergency fund.

But if your portfolio isn't that large, your EF should not be considered part of your AA, since a big enough drawdown of your EF would eventually trigger a rebalancing event and you would need to sell stocks, even if stocks are down. And if you decide you'd rather just change your AA than sell off stocks, your AA is meaningless.

Carpenterant
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Re: Is an emergency just mental accounting?

Post by Carpenterant » Fri May 31, 2019 8:38 pm

The question itself, is, in essence flawed. An emergency fund is self underwriting for expenses that may arise. If it is purely mental accounting, then so is health insurance, life insurance, car insurance, etc. With an emergency fund you are literally underwriting yourself for expenses that may arise.

If you are at a place in life where you can cash flow emergency expenses andnot sacrifice your financial goals then maybe you don’t need to self underwrite emergency expenses. Most of the population is not in a place to cash flow anything that comes up; so self underwriting in the form of an emergency fund is advised.

People who can easily accept debt expenses or who can cash flow emergency expenses probably don’t need an emergency fund. The rest of us self insure unforeseen expenses.

bck63
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Re: Is an emergency just mental accounting?

Post by bck63 » Sat Jun 01, 2019 4:11 am

Old_Dollar wrote:
Mon May 20, 2019 6:52 pm
The following is the definition of mental accounting from the Bogleheads wiki:
Mental accounting

The tendency for people to put their money into separate accounts based on a variety of subjective criteria, like the source of the money and intent for each account. According to the theory, individuals assign different functions to each asset group, which has an often irrational and detrimental effect on their consumption decisions and other behaviors. For example, people often have a special "money jar" or fund set aside for a vacation or a new home, while still carrying substantial credit card debt.

This definition could easily be rewritten as the following, the emphasis added is mine:
Mental accounting

The tendency for people to put their money into separate accounts based on a variety of subjective criteria, like the source of the money and intent for each account. According to the theory, individuals assign different functions to each asset group, which has an often irrational and detrimental effect on their consumption decisions and other behaviors. For example, people often have a special "money jar" or fund set aside for a vacation emergency or a new home, while still carrying substantial credit card debt.
In the case of an emergency fund the special "money jar" is often a high-yield savings account, money market account, etc.

Is there any reason why someone shouldn't just revisit their risk tolerance and redirect the emergency fund to that allocation in a brokerage account? For example, a portfolio that is 80/20 with an emergency fund in a money market account becomes a 75/25 portfolio with the emergency fund fully invested in the portfolio.
There is nothing wrong with assigning a purpose to each dollar. It is much better than drifting along without thinking about it. And in many cases, extremely limited assets makes an EF a very wise choice.

There are millions of people in this country who don’t have enough money to buy a new car tire. People who don’t see the value of an emergency fund apparently have no idea what that kind of struggle is like. Or they’ve forgotten what it’s like.

Bogleheads brings great value to personal finances. But it’s this kind of thread that can be nauseating.

Dandy
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Re: Is an emergency just mental accounting?

Post by Dandy » Sat Jun 01, 2019 7:56 am

Having separate accounts for specific purposes can be ok as long as it doesn't mask your true allocation or lead you into poor decisions. In a true emergency like a loss of job all your assets are in play not just the 6 or 9 months set aside in a high yield savings account. the emergency fund is part of your investment allocation whether you include it or not -- so I always included such accounts.

A person with a high credit card balance should be devoting most of their extra cash to paying it down. But, if they are also trying to break their credit card bad habits it might make some sense to have a modest cash account to fund small expense blips instead of keep charging. It may not be wise short term financing but an investment in changing habits for the better long term. Some people with credit card use issues cut them up. If so, better have some cash set aside while you also pay down the balances.

In the "old" days much of this mental accounting issue would have been a non issue as your investment portfolio was usually stocks/bonds/cash not just stocks/bonds. So a modest cash allocation of 5% or more might cover most things people set up separate accounts for.

I always had a decent allocation to cash, cash-like assets.

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Old_Dollar
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Re: Is an emergency just mental accounting?

Post by Old_Dollar » Sat Jun 01, 2019 7:58 am

After reading the responses it looks like my premise may have been flawed. Asset Allocation ≠ Personal Finance. Personal finance tends to dictate having an emergency fund while an asset allocation falls under the investing category of personal finance. As usual I learn a lot from you Bogleheads and it helps me make sense of everything. Thanks.
I am here solely to learn about investing.

pkcrafter
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Re: Is an emergency just mental accounting?

Post by pkcrafter » Sat Jun 01, 2019 8:51 am

Maybe we are looking at this backwards. One definition of investing risk is not having the money for something important when you need it. To me that means you should have some money available that is not tied to investments because something may come up were you need money and it isn't quickly accessible. That can happen when the market is in turmoil and that might be exactly when you need it.

Emergency fund? Yes.


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

bck63
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Re: Is an emergency just mental accounting?

Post by bck63 » Sat Jun 01, 2019 2:55 pm

Old_Dollar wrote:
Mon May 20, 2019 6:52 pm
The following is the definition of mental accounting from the Bogleheads wiki:
Mental accounting

The tendency for people to put their money into separate accounts based on a variety of subjective criteria, like the source of the money and intent for each account. According to the theory, individuals assign different functions to each asset group, which has an often irrational and detrimental effect on their consumption decisions and other behaviors. For example, people often have a special "money jar" or fund set aside for a vacation or a new home, while still carrying substantial credit card debt.
Of note, this definition from the wiki was obviously lifted, almost verbatim, from Investopedia.

Without attribution.

https://www.investopedia.com/university ... ioral5.asp

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arcticpineapplecorp.
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Re: Is an emergency just mental accounting?

Post by arcticpineapplecorp. » Sat Jun 01, 2019 3:10 pm

when Richard Thaler won the Nobel Prize in 2017 some people asked him what he was going to do with the prize money (around $1 million).

He replied, "Put it with the rest of my money. After all, money is fungible."

Now that's an economist for you.
"May you live as long as you want and never want as long as you live" -- Irish Blessing | "Invest we must" -- Jack Bogle

Northern Flicker
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Re: Is an emergency just mental accounting?

Post by Northern Flicker » Sat Jun 01, 2019 3:23 pm

Whether or not you view an emergency fund as part of the portfolio, it plays a different role than other fixed income assets. Such a cash position is to maintain some level of liquidity. Some portfolio construction methods allocate 5% to cash for portfolio liquidity. A retirement saver probably has liquidity requirements that do not increase as portfolio size increases so it is more convenient to express liquidity requirements in terms of months of living expenses.

Additionally, assets to provide liquidity should not factor into the implementation of duration requirements for the fixed income part of the portfolio. It would not be advisable to extend bond duration so that the duration in combination with one's emergency cash meets duration requirements. This would essentially drain the liquidity being provided by the emergency cash.

Because the emergency fund does not need to grow unboundedly as portfolio grows, and because it should not figure into the duration design of the fixed income portfolio, many people find it advantageous to account for it mentally as an emergency fund. How it can figure into portfolio risk management is that if you have an emergency fund, you can tolerate more portfolio variance than if you lack one.

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Re: Is an emergency just mental accounting?

Post by lotusflower » Sat Jun 01, 2019 4:24 pm

Aside from the important behavioral factors mentioned in the replies, it's purpose is also to keep your arithmetic simple. Your asset allocation is in percentages of your portfolio size, e.g. 75/25. Your emergency fund should be a percentage of your annual expenses, e.g. 50%. If your expenses change, then your EF should change, but your AA might stay the same.

Similarly if your portfolio doubles, that has no effect on your EF but your fixed-income investments may need to be tweaked to maintain your AA.

Sure you could combine it all and use a spreadsheet to verify that your EF at the right level, but that's harder to describe in the forums. Your EF should be earning close to what your Fixed-income investments earn anyway, so it's not like you're losing a lot of money, maybe you're paying a bit of a premium to make sure it's absolutely liquid.

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