how to do the math?

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Zoey
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Location: NE Ohio

how to do the math?

Post by Zoey »

I am not sure how an emergency fund is figured into a porfolio. If I have exactly 100,000.00 to create a portfolio and I know I want to hold 200,000.00 in a mm acct. for emergencies, new car, possible remodeling, do I then figure my portfolio percentages on the 800,000.00? If I want to do 50% stock and 50% bonds, do I figure both those from the 800,000.00 and pretend the 200,000.00 doesn't exist for the sake of the portfolio?

Thanks for any help with understanding this.

Zoey
xenial
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Post by xenial »

Zoey, it comes down to personal preference. The conventional wisdom around here is that the emergency fund is separate from your investment portfolio, so you'd hold $400K of stocks and $400K of bonds. That said, $200K is an awfully large amount for emergencies and the other short-term expenses you've mentioned. So you may wish to treat it differently, though if you really spend the money, you'd then have to rebalance your portfolio.

Best wishes,
Ken
Tramper Al
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Post by Tramper Al »

I don't have an emergency fund per se, but yes you would exclude that amount from your AA completely.

If I have a cash-need emergency, I will remove funds according to my AA -- whichever asset is at that time above-target -- just as I plan to when drawing funds after retirement. I can also use a line of credit. That can be a very cheap (free) way to prepare an emergency fund that you may never end up needing to use.

When I do have a forseeable expense, I do put that into my spreadsheet, effectively removing it from my AA. I think to the extent that you are budgeting for new car, remodelling, etc., those expenses may not be emergency fund material.

As for the math, your numbers aren't adding up for me, if the grand total is $100K. And $200K seems like quite a lot for emergencies, to me, unless you are a motorcycle daredevil, or are self-insuring in some way.
Last edited by Tramper Al on Wed Jan 02, 2008 12:29 pm, edited 2 times in total.
dougpnca
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Post by dougpnca »

Not sure that there's an official answer to your question but you'll probably get a variety of views on this. I don't bother including my emergency fund, daily working cash, and other immediate needs from my investment portfolio. Depending upon your comfort level, emergency cash may be as little as 90 days or as much as 2 years. Those funds need to be liquid, ie., MM, checking account, short term savings or similar vehicle. Your investment portfolio, on the other hand, needs to be long term money that you don't plan to access for years (e.g. house purchase) or decades (retirement).

Whether you include or exclude your immediate cash may impact your total portfolio return. Cash is generally low return so including it usually lowers your return. Since it is an asset you own, it is part of your portfolio. But if you're just reporting to yourself anyway so it's up to you. I wouldn't get too hung up on it.

dougP
no matter where you go, there you are
Topic Author
Zoey
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Location: NE Ohio

Post by Zoey »

Thanks for your replies, you helped a lot. These figures were hypothetical to keep it simple for me to understand. I just didn't know how to account for the money we are holding aside for emergencies, new car, remodleing, etc.

Thanks, Zoey
sscritic
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Re: how to do the math?

Post by sscritic »

Zoey wrote:I am not sure how an emergency fund is figured into a porfolio. If I have exactly 100,000.00 to create a portfolio and I know I want to hold 200,000.00 in a mm acct. for emergencies, new car, possible remodeling, do I then figure my portfolio percentages on the 800,000.00? If I want to do 50% stock and 50% bonds, do I figure both those from the 800,000.00 and pretend the 200,000.00 doesn't exist for the sake of the portfolio?

Thanks for any help with understanding this.

Zoey
Although many people write here about asset allocations as percentages, they are not. An asset allocation is an allocation of dollars.

For example, there are two possible versions of you. The first you has an asset allocation of

mm $200,000
stocks $400,000
bonds $400,000

That is your asset allocation. Joe Blow comes along and says to you, "You have a 50-50 asset allocation, since your portfolio only has $800,000 in it." Jane Glow comes along and says to you, "You have a 40-60 asset allocation, because mm is just very short term bonds so your portfolio is only 40% stocks."

The second version of you has an asset allocation of

mm $200,000
stocks $500,000
bonds $300,000

Again, Joe Blow and Jane Glow will give you a song and dance about what percentages you should compute for your allocation, but your allocation is the same no matter how Joe and Jane label it.

The real question for you is not what Joe and Jane say about your allocation, but would you rather have $400,000 in stocks or $500,000 in stocks. Don't get distracted by the percentages.
pkcrafter
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emergency fund

Post by pkcrafter »

Hi Zoey,

An emergency fund is just really for unexpected events. It should not be part of your long-term portfolio, but it shouldn't be confused with short term goals like a new car, remodeling, etc. Those are goals that should have their own asset allocation and funding. And in cases where the goal is within 5 years, the money should not be in stocks. So, doing it this way means you don't have to hold so much in an emergency fund.

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.
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mas
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Re: how to do the math?

Post by mas »

sscritic wrote:Although many people write here about asset allocations as percentages, they are not. An asset allocation is an allocation of dollars.

...

The real question for you is not what Joe and Jane say about your allocation, but would you rather have $400,000 in stocks or $500,000 in stocks. Don't get distracted by the percentages.
To me the real distinction is what you do when you add more money. If the $200K is really an emergency fund, it is probably a fixed $ amount. So you would add 50/50 to stocks and bonds - no additions to the cash. If your asset allocation really includes 20% cash, you would add 20% of all new money to cash as well as stocks and bonds. Same applies to withdrawals (emergency withdrawals may differ).

There is no right answer, just what you feel comfortable with.
Cipro
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Post by Cipro »

I currently hold a separate emergency fund that if added to my portfolio, would increase its overall value by about 8%. I determined the size of this fund based upon my current salary and estimates of costs to keep everything afloat should I lose my job for 6 to 12 months. This seems like a lot of money to keep invested in MM accounts. Wonder if others choose to invest this money and if necessary, sell and pay taxes on capital gains.

Any thoughts?

Thanks
sport
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Post by sport »

Cipro wrote:I currently hold a separate emergency fund that if added to my portfolio, would increase its overall value by about 8%. I determined the size of this fund based upon my current salary and estimates of costs to keep everything afloat should I lose my job for 6 to 12 months. This seems like a lot of money to keep invested in MM accounts. Wonder if others choose to invest this money and if necessary, sell and pay taxes on capital gains.

Any thoughts?

Thanks
If your emergency fund is meant to provide for a 12 month emergency, you could split the amount into 4 parts. The first part can be in a MM fund, the other three parts can be split equally into 3 month, 6 month, and 9 month CDs. This will give you some protection against falling interest rates. As each CD matures, renew it for 12 months. This will give you a one year CD ladder with quarterly steps. If CDs have better yields than the MM fund, this would be a reasonable alternative. If the MM fund looks better, keep it there.

Best wishes,
Jeff
Cipro
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Post by Cipro »

Thanks Jeff. That's a good idea though not sure how much advantage - certainly worth looking into.

Rob
dougpnca
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Post by dougpnca »

My level on an emergency fund has always been to have at least a one year supply of ready cash. The MM plus laddered CDs is probably the safest plan to maximize liquidty & still make a few bucks, especially now with CD yields being up there with MM for the first time in a long time.

If you're working for someone else, you're vulnerable to all the horrors of employment. You always want to have the freedom to just walk away should the situation become untenable. Jobs are like buses - another one will come along in 20 minutes but you need to be able to handle the wait.

dougP
no matter where you go, there you are
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