Struggling to understand emergency fund math

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Pomegranate
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Struggling to understand emergency fund math

Post by Pomegranate » Sun Oct 13, 2019 11:59 am

Most of the folks recommend 6 months expenses.
  • Me & my wife are currently employed and my current estimation is it would take 2-3 months to find another employer in case of lay off. We can leave on single income so from this perspective 6 months is too much
  • In case of major recession I believe ppl can be unemployed for 1-2 years so 6 moths fund is too small
Thoughts?

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Wiggums
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Re: Struggling to understand emergency fund math

Post by Wiggums » Sun Oct 13, 2019 12:06 pm

I don’t disagree with your reasoning if that works for you. We lived on one paycheck too, but had the same employer.

As you get older and/or you require a higher salary, there are less jobs available. I personally choose to have more cash, which allows me to ignore talk of a possible market crash or recession.

I don’t think there is any magic number. If you exhaust your cash, you will need to sell something to meet your expenses. Others have suggested a HELOC. Some have no dedicated EF allocation. You just need to weigh the risk.
Last edited by Wiggums on Sun Oct 13, 2019 12:15 pm, edited 3 times in total.

retired@50
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Re: Struggling to understand emergency fund math

Post by retired@50 » Sun Oct 13, 2019 12:06 pm

Pomegranate wrote:
Sun Oct 13, 2019 11:59 am
Most of the folks recommend 6 months expenses.
  • Me & my wife are currently employed and my current estimation is it would take 2-3 months to find another employer in case of lay off. We can leave on single income so from this perspective 6 months is too much
  • In case of major recession I believe ppl can be unemployed for 1-2 years so 6 moths fund is too small
Thoughts?
Pomegranate,
When I think about the emergency fund, I try to ask the question, "Where am I vulnerable?". In other words, if you have low seniority in a job where seniority matters, then you are vulnerable. If you and your wife work at the same company, then you are both vulnerable to a the same firm. On the other hand, if you are a tenured professor, you are probably less vulnerable. I don't think having a "current estimate" of how long it would take you to find a job is much of a security blanket, but each person's emergency fund is really a matter of your risk tolerance. Regards,

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JoMoney
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Re: Struggling to understand emergency fund math

Post by JoMoney » Sun Oct 13, 2019 12:07 pm

There are disaster scenarios where any amount can be too small.
And yet many Americans struggle by without enough savings to miss a single paycheck.
It's not a math equation unless you're trying to match some specific liability, I think of it more as a number that just helps me sleep well a night knowing there's a big cushion between my paycheck and having to raid funds earmarked for retirement or something else.
Some people don't have an "emergency fund" at all, preferring to lump all their money together without any sort of bucketing / earmarking of funds.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

MathWizard
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Re: Struggling to understand emergency fund math

Post by MathWizard » Sun Oct 13, 2019 12:13 pm

Pomegranate wrote:
Sun Oct 13, 2019 11:59 am
Most of the folks recommend 6 months expenses.
  • Me & my wife are currently employed and my current estimation is it would take 2-3 months to find another employer in case of lay off. We can leave on single income so from this perspective 6 months is too much
  • In case of major recession I believe ppl can be unemployed for 1-2 years so 6 moths fund is too small
Thoughts?
You are smart in arranging expenses so that you can live on one income. This really limits the risk by a lot

Other than job loss, the EF does not have to be large. Maybe roof or car replacement.

The odds are low that you both will be laid off at the same time if you don't both work at the same employer or within the same economic sector, especially one with cyclic employment.

Our way to guard against that small probability was to max out Roth's, even if it reduced our EF for a time. Contributions can be withdrawn from a Roth at any time (but not put back in), without taxes or penalty. In this way, you are most likely saving for retirement, but this guards against the worst case, but which is unlikely to happen.

Tal-
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Re: Struggling to understand emergency fund math

Post by Tal- » Sun Oct 13, 2019 12:18 pm

I think that the correct emergency fund is much more art than science, and using a hard-and-fast rule like "thou must have 6 months in savings" is over simplified. I think the correct answer is far more nuanced, and would a far more comprehensive summary of your situation.

With that said, your reasoning makes a lot of sense. If you two are without kids, dual income in non-correlated jobs, with enough income from either job to live off of in a pinch, those are all factors that would suggest a smaller-than-normal emergency fund.
Debt is to personal finance as a knife is to cooking.

KlangFool
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Re: Struggling to understand emergency fund math

Post by KlangFool » Sun Oct 13, 2019 12:19 pm

Pomegranate wrote:
Sun Oct 13, 2019 11:59 am
Most of the folks recommend 6 months expenses.
  • Me & my wife are currently employed and my current estimation is it would take 2-3 months to find another employer in case of lay off. We can leave on single income so from this perspective 6 months is too much
  • In case of major recession I believe ppl can be unemployed for 1-2 years so 6 moths fund is too small
Thoughts?
1) Have you ever been unemployed in a recession?

2) I considered the fixed income portion of my AA as my second level emergency fund.

KlangFool

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FiveK
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Re: Struggling to understand emergency fund math

Post by FiveK » Sun Oct 13, 2019 12:35 pm

Using Give yourself at least enough buffer to avoid worries about bouncing checks as a minimum seems reasonable.

How high to go above that is anyone's guess. You'll know after the fact if you had too much or too little. I agree with those who have suggested that your situation might indicate a "lower than average" number of months' expenses, but there is no predictive and deterministic math.

GAAP
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Re: Struggling to understand emergency fund math

Post by GAAP » Sun Oct 13, 2019 12:56 pm

I remember seeing an estimate that it takes about 1 month per $10K of annual income to find an equivalent paying job. It may be higher now -- in particular if you work in a specialized industry. Many of my former coworkers have drastically underestimated how long the job search takes.

You didn't say much about how you define "emergency". To me, an emergency is something you couldn't plan for and had no reason to expect. Many of the items that people tend to lump into "emergency" do not qualify by that definition (e.g., unexpected health bills, car troubles, car repair replacement after collision). If you bought insurance, you chose a product that has a known and predictable potential expense such as copays, co-insurance, deductibles, or lack of replacement value for a vehicle. Since you know it is a potential cost that may occur at some unknown time in the future, you should set aside funds in reserve for that eventual outcome. I would even include vehicle depreciation and costs for major home repairs (new roof, furnace replacement, etc.) in that category. If you work in a job that is likely subject to layoffs or seasonal downturns, then that potential is also not an emergency.

In your situation, is 2-3 months sufficient? Perhaps, assuming none of those potential expenses occur at the same time you have job loss. Your ability to survive on one income is the only reason I would be that optimistic.

My view is probably not typical for this forum...
“Adapt what is useful, reject what is useless, and add what is specifically your own.” ― Bruce Lee

runner3081
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Re: Struggling to understand emergency fund math

Post by runner3081 » Sun Oct 13, 2019 1:13 pm

Something else to keep in mind is that healthcare premiums can go up significantly. If we had to COBRA, the rates would go up x 10!

However, we don't account for this in the eFund. After cash, the HSA is available (from receipts we just paid with case), then taxable investments, then ROTH, etc as things get progressively worse.

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vineviz
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Re: Struggling to understand emergency fund math

Post by vineviz » Sun Oct 13, 2019 1:25 pm

Pomegranate wrote:
Sun Oct 13, 2019 11:59 am
Most of the folks recommend 6 months expenses.
  • Me & my wife are currently employed and my current estimation is it would take 2-3 months to find another employer in case of lay off. We can leave on single income so from this perspective 6 months is too much
  • In case of major recession I believe ppl can be unemployed for 1-2 years so 6 moths fund is too small
Thoughts?
Financial advice often uses shorthand phrases like "emergency fund", but these can sometimes obfuscate the underlying financial principles.

The idea is that a household should have enough financial capital withstand unexpected shocks (either a period of unemployment/underemployment or a major unplanned expenses) without undue stress. This does NOT mean that the emergency fund need to be entirely in cash instruments, IMO, just that the household have enough liquidity to persevere scenarios with a reasonable probability of occurring.

A household with significant taxable brokerage or Roth IRA accounts might not need much of a discrete emergency fund at all. Another approach would be to use a fund like Vanguard Target Retirement Income (VTINX) as the emergency fund: 8 months worth of expenses in VTINX would be provide as much liquidity as 6 months worth of expenses in a money market fund, with much higher expected returns.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Jags4186
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Re: Struggling to understand emergency fund math

Post by Jags4186 » Sun Oct 13, 2019 1:54 pm

I keep enough emergency fund to be able to grab 6-8 savings account bonuses a year. That amount is around $50k.

We have enough money in an HSA to cover 2 full years of max OOP expenses. $50k plus 6 months of state unemployment benefits means both me and my spouse could go a full year of being unemployed at the same time before we had to consider selling equities.

Ferdinand2014
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Re: Struggling to understand emergency fund math

Post by Ferdinand2014 » Sun Oct 13, 2019 2:34 pm

Pomegranate wrote:
Sun Oct 13, 2019 11:59 am
Most of the folks recommend 6 months expenses.
  • Me & my wife are currently employed and my current estimation is it would take 2-3 months to find another employer in case of lay off. We can leave on single income so from this perspective 6 months is too much
  • In case of major recession I believe ppl can be unemployed for 1-2 years so 6 moths fund is too small
Thoughts?
I view an emergency fund as highly liquid investments to cover anything that would would otherwise result in loss of my home or groceries on the table. I don't consider a roof repair, new furnace, car repair or medical bill within policy to be considered an emergency as they are expected events over time. I like Jo Money's comment that enough to sleep well is as good as anything. For me, I keep X dollars in treasury-bills in a taxable account that will cover enough expenses for 1 year if both my wife and I were completely unable to work. If she could only work this would last about 2 years. If I could only work we wouldn't touch it at all as we use all of her income towards saving and retirement. I am a physician and she is an RN. Jobs are easy to get anywhere. My bigger worry would be a health scare resulting in loss of employment which could be a double whammy of expenses and job loss. Every situation is unique. Our plan lets us sleep well. As an aside, I have started to aggressively invest more money into our S&P 500 index fund in taxable as we already max out my SEP and her 403b and less into more cash. I figure I can count on the index fund to at least give us 50 cents on the dollar in a tsunami event of all cash used up, job loss for both of us, major health bills and 2008 all over. Beyond that having good disability and term life insurance and being debt free is about all you can do.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett

Ferdinand2014
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Re: Struggling to understand emergency fund math

Post by Ferdinand2014 » Sun Oct 13, 2019 2:36 pm

JoMoney wrote:
Sun Oct 13, 2019 12:07 pm
There are disaster scenarios where any amount can be too small.
And yet many Americans struggle by without enough savings to miss a single paycheck.
It's not a math equation unless you're trying to match some specific liability, I think of it more as a number that just helps me sleep well a night knowing there's a big cushion between my paycheck and having to raid funds earmarked for retirement or something else.
Some people don't have an "emergency fund" at all, preferring to lump all their money together without any sort of bucketing / earmarking of funds.
+1

The sleep well test works well for me.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett

HomeStretch
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Re: Struggling to understand emergency fund math

Post by HomeStretch » Sun Oct 13, 2019 2:44 pm

It’s a judgment call. My thoughts run the same as some prior posters...

If one spouse became unemployed and you can live on just the other’s income, I think 6-12 months is reasonable. You should get unemployment for awhile to soften the financial blow.

If you are at higher risk for unemployment, both work at same employer or same sector, hard to find jobs in your field, if one has significant health issues, planning for kids, etc., then I would lean more towards 12 months.

If you have a larger portfolio with a fixed income allocation that has Taxable/Roth accounts, then a separate emergency fund likely isn’t necessary as fixed income allocation is an emergency cushion.

Work towards 6 months and see how that feels.

stoptothink
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Re: Struggling to understand emergency fund math

Post by stoptothink » Sun Oct 13, 2019 2:54 pm

HomeStretch wrote:
Sun Oct 13, 2019 2:44 pm
It’s a judgment call. My thoughts run the same as some prior posters...

If one spouse became unemployed and you can live on just the other’s income, I think 6-12 months is reasonable. You should get unemployment for awhile to soften the financial blow.
Both stable jobs and we could easily live on one income (realistically, half of one of our incomes), we keep anywhere from $1k-$20k in an Ally account depending on time of year. In a real "emergency" we have 6 figures in Roth IRA contributions and a similar amount in credit, nearly $50k in HSAs in case it is a medical emergency, etc. IMO, emergency funds are a baseline for people/families that don't have a lot of financial stability, for probably most on this board there are several layers of emergency funds.

rossington
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Re: Struggling to understand emergency fund math

Post by rossington » Sun Oct 13, 2019 3:24 pm

OP also don't forget you might have to move for a new job.
"Success is going from failure to failure without loss of enthusiasm." Winston Churchill.

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Re: Struggling to understand emergency fund math

Post by Jack FFR1846 » Sun Oct 13, 2019 3:36 pm

Buy iBonds. These can act as part of your investments, considered bonds and they can also be considered emergency fund. At least for paper bonds (yes, I know now you can only get $5k a year), I can cash them at my credit union (DCU) and the funds are immediately available. I have gone in with a stack of $50k worth of bonds to cash. They simply had me go to one of the executive's offices and they imputed them as I signed.

I believe one year is a minimum for e Fund. I have the iBond thing going so am at about 7 years spending in immediately available funds.
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Ybsybs
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Re: Struggling to understand emergency fund math

Post by Ybsybs » Sun Oct 13, 2019 3:59 pm

I like having enough in laddered CDs to cover twelve months of current living expenses with one of two jobs lost.

In the case where one of us were unexpectedly without pay, we most likely would be cutting back in most areas so the extra money would probably last more than twelve months.

We would also use that money for insurance deductibles, last minute flights to attend a funeral, and so on if we could not immediately cash flow it. At one point we chose to have a bunch of sinking funds to cover those sorts of things but we decided it was more complex than we needed it to be.

Uncorrelated
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Re: Struggling to understand emergency fund math

Post by Uncorrelated » Sun Oct 13, 2019 4:01 pm

The source of the problem of not understanding emergency fund math, is because there is no math behind emergency funds.


The most common explanation of emergency funds relies on market timing. Theory: keep an emergency fund of 6 months. Practice: keep an emergency fund of 6 months, if you lose your job, then decrease the emergency fund until it is empty "to avoid selling stocks". If you look at this from a portfolio allocation standpoint, then you are trying to time the market (your asset allocation changes) by using your personal emergency as an indicator. If you follow the theory, then your emergency fund should rebalanced back to 6 months as soon as you use a part of it.


Financial theory states that you get the highest return for a given amount of risk if your proportion of assets stays the same over the entire time period. Pick an asset allocation (i.e. 70% stocks, 30% bonds) and stick with it. An emergency fund with a fixed amount of cash is fundamentally incompatible with this view. An emergency fund exists for your convenience only. There is no good reason to keep a large emergency fund in cash if you have 5 years of liquid assets in taxable accounts.

I define an emergency as any event that requires money faster than I can get it from my brokerage. According to that definition, job loss is not an emergency.

If you have a small emergency fund and you are worried about a market crash correlated with personal emergency (job loss? Car total loss?), the proper response is to use a more defensive asset allocation rather than increasing the size of your emergency fund. From this perspective, moving your emergency fund into bonds does not make any sense.

KlangFool
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Re: Struggling to understand emergency fund math

Post by KlangFool » Sun Oct 13, 2019 4:03 pm

rossington wrote:
Sun Oct 13, 2019 3:24 pm
OP also don't forget you might have to move for a new job.
And, you may not be able to sell and rent out the current house and have to continue to pay the current house's mortgage.

KlangFool

EnjoyIt
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Re: Struggling to understand emergency fund math

Post by EnjoyIt » Sun Oct 13, 2019 4:08 pm

KlangFool wrote:
Sun Oct 13, 2019 12:19 pm
Pomegranate wrote:
Sun Oct 13, 2019 11:59 am
Most of the folks recommend 6 months expenses.
  • Me & my wife are currently employed and my current estimation is it would take 2-3 months to find another employer in case of lay off. We can leave on single income so from this perspective 6 months is too much
  • In case of major recession I believe ppl can be unemployed for 1-2 years so 6 moths fund is too small
Thoughts?
1) Have you ever been unemployed in a recession?

2) I considered the fixed income portion of my AA as my second level emergency fund.

KlangFool
This right here.
Money is fungible and buckets is nothing more than mental gymnastics.
If you have a taxable account it will serve well as an emergency fund since you can always sell bonds in case of emergency.

Reality is, your emergency fund is part of your asset allocation already. Unless it is kept in a high yield savings account or money market fund that is on par with bond yields it is just a tax drag.

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Pomegranate
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Re: Struggling to understand emergency fund math

Post by Pomegranate » Sun Oct 13, 2019 5:59 pm

Uncorrelated wrote:
Sun Oct 13, 2019 4:01 pm
The source of the problem of not understanding emergency fund math, is because there is no math behind emergency funds.


The most common explanation of emergency funds relies on market timing. Theory: keep an emergency fund of 6 months. Practice: keep an emergency fund of 6 months, if you lose your job, then decrease the emergency fund until it is empty "to avoid selling stocks". If you look at this from a portfolio allocation standpoint, then you are trying to time the market (your asset allocation changes) by using your personal emergency as an indicator. If you follow the theory, then your emergency fund should rebalanced back to 6 months as soon as you use a part of it.


Financial theory states that you get the highest return for a given amount of risk if your proportion of assets stays the same over the entire time period. Pick an asset allocation (i.e. 70% stocks, 30% bonds) and stick with it. An emergency fund with a fixed amount of cash is fundamentally incompatible with this view. An emergency fund exists for your convenience only. There is no good reason to keep a large emergency fund in cash if you have 5 years of liquid assets in taxable accounts.

I define an emergency as any event that requires money faster than I can get it from my brokerage. According to that definition, job loss is not an emergency.

If you have a small emergency fund and you are worried about a market crash correlated with personal emergency (job loss? Car total loss?), the proper response is to use a more defensive asset allocation rather than increasing the size of your emergency fund. From this perspective, moving your emergency fund into bonds does not make any sense.
Hmm that's a bunch of interesting thoughts :sharebeer
I have MM as a part of my portfolio so I believe I can just rethink AA :sharebeer

KlangFool
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Re: Struggling to understand emergency fund math

Post by KlangFool » Sun Oct 13, 2019 6:53 pm

OP,

Basically, you need a plan to handle your financial emergency. One of the scenarios that you need to plan for is unemployment in a recession with a market downturn. In those cases, I use a 50% stock market drop and the bond stays the same as my base assumption.

I have multiple tiers of emergency funds. You could adjust the scheme to fit your situation.

0) Gold jewelry

1) Cash at home

2) Cash in checking account/MM fund

3) The fixed income portion of my 60/40. I set a low limit of 5 years of expense for my fixed income.

4) Stock.

My portfolio is spread across taxable, Roth IRA, Trad IRA/401K/457.

The question you need to ask and plan for is

A) If I am unemployed for X months, how long each tier of money can last before I need to move on to the next tier.

B) What is the permanent damage to my financial future if I move to the next tier.

In the most extreme example, you are 100/0 with zero emergency fund. So, you will suffer a permanent 50% loss for every dollar of stock you sell.

KlangFool

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oldcomputerguy
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Re: Struggling to understand emergency fund math

Post by oldcomputerguy » Mon Oct 14, 2019 1:22 pm

I removed an off-topic post that added nothing to the discussion. Please keep your replies on-topic to the OP's query.
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JBTX
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Re: Struggling to understand emergency fund math

Post by JBTX » Mon Oct 14, 2019 1:36 pm

The way we are set up is these funds are multi purposed. Approx 9mos in cash/bank accounts. Some in high yield savings accounts, some chasing bank bonuses. I have to keep a fair amount in out base bank account for multiple credit cards coming due.

Then another 6+ months or so ibonds. I consider this additional reserve plus part of bond allocation, plus an additional source for kids college education if needed.

cashboy
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Re: Struggling to understand emergency fund math

Post by cashboy » Mon Oct 14, 2019 5:15 pm

OP,

i think that, like most things related to investments or finances, perhaps the answer is 'it depends on your personal situation'. and yes, it can be frustrating to hear that; i know.

you have received some good advice in some of the replies. leverage those perspectives that appeal to you (like a buffet) to create and maintain your own plan (which will likely change over time). also, if you search this forum you will find many 'lively' threads on the subject that might provide additional perspectives. :wink:

me? i read all of the posts i could find on the subject and created and maintain 'my' plan (including: amounts and assets) that lets me sleep at night.

just an opinion, but i think that emergency funds is one of those things that if there was one right way to do it everyone would be doing it that way. so, since everyone is not doing it the same way there is no one right way to do it.

:sharebeer
Three-Fund Portfolio: FSPSX - FXAIX - FXNAX (with slight tilt of CD - CASH - Canned Beans - Rice - Bottled Water)

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