I'd like to challenge the logic behind a 'disaster fund'

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YoungBoglehead
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I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

So I've had this thought a few times wanted to get some input. I really think I'm correct here so try to really understand.

The standard procedure is to keep maybe 3-6 months of living money in your bank account to be easily available in case of a disaster, correct?

Well, certain investments, such as ETFs (or something else, commodities maybe) can be moved into your bank account or be turned into cash fairly quickly correct?

Well.. yes, investments can be risky, I could wake up tomorrow and have much much less in my investment account than I do today. This is the reasoning behind a disaster fund. If you lose your job or have some unexpected emergency, the thought is that you don't want to have to remove investments because they could be at a big 'low', correct?

Well, let's think about this. Bogleheads of all people should agree that you cannot time the market. We all hope it goes up over time, and that on average it rises, and history shows us it will and we expect it to (on a large scale)

So intentionally keeping money out of funds for an emergency is almost an equivelant of 'timing the market', sure, the markets could be down during some disaster, however they could also be up. Removing that money and thinking "this is a bad time to remove my money" is the same as thinking "now is a good time to buy, the market is low" or "I should sell now, the market is high"


Using the Bogglehead theory of never timing the market, and assuming you have a decent chunk of investments where even if you took an 80% loss overnight you would still have enough to survive for 3-6 months, should't we keep more invested?

Why keep 3-6 months (which could easily be 5 grand) sitting in a bank account when you could have 3 grand of that invested? Keeping it out for fear of removing stocks at a low point is market timing. Just keep enough in the bank to pay for your rent, expected monthly expenses, and invest the rest.


Makes sense, right? -and for the record, I currently keep 3-6 months of savings in my bank account. Just want to share this idea
Last edited by YoungBoglehead on Wed Dec 04, 2013 5:38 pm, edited 2 times in total.
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tc101
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by tc101 »

I think you are correct. There can be a certain sense of stability that comes with cash in the bank, but as you point out, it is a kind of expensive illusion.
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YoungBoglehead
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

tc101 wrote:I think you are correct. There can be a certain sense of stability that comes with cash in the bank, but as you point out, it is a kind of expensive illusion.

Cool. I've never heard anyone say this before but have thought it for a while.

If I were to start using this idea, I'd probably keep 2x my monthly expenses in my bank account or so, but no need for 3-6 months living expenses available. It's in stocks, where it's more likely to earn money than lose.
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Drew31
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Drew31 »

Two thoughts.

1. I don't think you're killing the idea of having a "disaster" fund. Even you said that you'd still keep 2x expenses on hand. To me, it just seems you're saying you're comfortable at 2 months instead of the oft-recommended 3-6 months. It's a risk story to me.

2. Also sounds like an idea you would hear after a
150% increase in stocks. Would you still be proposing this in October 2008?
Professor Emeritus
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Professor Emeritus »

Ah youth!!
"Those who cannot remember the past are condemned to repeat it."

"It's in stocks, where it's more likely to earn money than lose."

So the stock market crashes and you lose your job. But your mortgage is due .
Now you have to sell out at the bottom

etcetera etcetera etcetera

You are confusing liquidity with steady prices.
Scotttheking
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Scotttheking »

For myself, I have 3 tiers:
1 - 1 month in a local savings account, instant transfer
2 - ~2-3 months in an online savings account and CD, short transfer
3 - Investment accounts to cover the rest

The idea being that I can cover more frequent "bumps" with #1, cover less frequent issues with #2, and #3 would be for catastrophes only.
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YoungBoglehead
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

Drew31 wrote:Two thoughts.

1. I don't think you're killing the idea of having a "disaster" fund. Even you said that you'd still keep 2x expenses on hand. To me, it just seems you're saying you're comfortable at 2 months instead of the oft-recommended 3-6 months. It's a risk story to me.

2. Also sounds like an idea you would hear after a
150% increase in stocks. Would you still be proposing this in October 2008?
1. - I actually am saying do away with the disaster fund. 2x expenses is just an 'expenses' fund, to pay for things you need with some leeway. 3-6 months is specifically for a 'disaster'

2. - I'm actually not including feelings in this logic. Just pure logic as a Boglehead would have taught me, and not timing the market. Purely based on logic, it seems keeping the emergency part of the fund invested will be better on average

(seems is the key word, I'm still asking for input)
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by pkcrafter »

Professor Emeritus wrote:Ah youth!!
"Those who cannot remember the past are condemned to repeat it."

"It's in stocks, where it's more likely to earn money than lose."

So the stock market crashes and you lose your job. But your mortgage is due .
Now you have to sell out at the bottom

etcetera etcetera etcetera

You are confusing liquidity with steady prices.
+1 etcetera.

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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bottlecap
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by bottlecap »

I think you're wrong. Holding an emergency fund is not market timing. The reason you don't want it in the market is because you don't want to have 6 months expenses that becomes 3 months because of a market drop and then lose your job or have an emergency that requires the full 6 months. If you sell some of your investment portfolio after such a drop, you will likely miss the rebound, compounding your losses. That's not timing, it's understanding that markets often rebound before you can save enough to refund your investment.

The reason this is not market timing is because you acknowlege that you don't know when the market will drop and you don't know when you will have an emergency. Under your premise, holding any cash at any time is market timing, which doesn't make sense - why have a checking account?

JT
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Mingus »

Drew31 wrote:

2. Also sounds like an idea you would hear after a
150% increase in stocks. Would you still be proposing this in October 2008?
I was just thinking this and laughing to myself. After I was laid off August of 2008, I was glad I had a healthy emergency fund. I didn't touch it, but it was there.

When the world almost fell apart and I was laid off again in April of 2009, I was exceedingly glad I had a large healthy emergency fund. Man oh man, that would have been pretty crazy had I had my emergency fund in the market at that time... That being said, at the time it was well over six months expenses. I slept well.
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YoungBoglehead
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

Professor Emeritus wrote:Ah youth!!
"Those who cannot remember the past are condemned to repeat it."

"It's in stocks, where it's more likely to earn money than lose."

So the stock market crashes and you lose your job. But your mortgage is due .
Now you have to sell out at the bottom

etcetera etcetera etcetera

You are confusing liquidity with steady prices.
When I say stocks, I should have specified. I mean invested in the smart Boglehead way. The overall stock market is more likely to go up than down over time. Yes I know history is no indicator of future performance and you can't predict but technically speaking this statement is true. That's why we're all here.

Also, yes I'm aware you gave a worst case scenario example, however this is covered. See my response above. I think in a worst case scenario everyone would be saying "ah I wish I did ___ differently" but we can't just focus on the worst case times, instead we have to look at the whole picture right?
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YoungBoglehead
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

bottlecap wrote:I think you're wrong. Holding an emergency fund is not market timing. The reason you don't want it in the market is because you don't want to have 6 months expenses that becomes 3 months because of a market drop and then lose your job or have an emergency that requires the full 6 months. If you sell some of your investment portfolio after such a drop, you will likely miss the rebound, compounding your losses. That's not timing, it's understanding that markets often rebound before you can save enough to refund your investment.

The reason this is not market timing is because you acknowlege that you don't know when the market will drop and you don't know when you will have an emergency. Under your premise, holding any cash at any time is market timing, which doesn't make sense - why have a checking account?

JT
I think you may have missed part of my original post, I actually cover this situation. I'll quote myself
YoungBoglehead wrote: Using the Bogglehead theory of never timing the market, and assuming you have a decent chunk of investments where even if you took an 80% loss overnight you would still have enough to survive for 3-6 months, should't we keep more invested?
So given the situation where even if we had some massive crash and stock values dropped 80% over night (very extreme) and you still had enough for 6 months living is the question.

This is probably the case for many of us
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Drew31
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Drew31 »

YoungBoglehead wrote:
Drew31 wrote:Two thoughts.

1. I don't think you're killing the idea of having a "disaster" fund. Even you said that you'd still keep 2x expenses on hand. To me, it just seems you're saying you're comfortable at 2 months instead of the oft-recommended 3-6 months. It's a risk story to me.

2. Also sounds like an idea you would hear after a
150% increase in stocks. Would you still be proposing this in October 2008?
1. - I actually am saying do away with the disaster fund. 2x expenses is just an 'expenses' fund, to pay for things you need with some leeway. 3-6 months is specifically for a 'disaster'

2. - I'm actually not including feelings in this logic. Just pure logic as a Boglehead would have taught me, and not timing the market. Purely based on logic, it seems keeping the emergency part of the fund invested will be better on average

(seems is the key word, I'm still asking for input)
1. Isn't that just mental accounting? You still have 2 months expenses saved to spend. Call it whatever you wish. You've just shrunk the size of cash savings.

2. Sure, logically it sounds great, but what do you do when the things Professor mentions happen? Or something far worse?
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by mhc »

OP,

there are many around here that agree with you. I interpret what you are saying as once your portfolio gets large enough, the need to keep money in the bank diminishes. Personally, I keep ~1 month in my saving account in a local bank. I eventually want to move to half that.

My emergency fund goes like this:
1. credit card
2. cash flow (base pay, espp, rsu's, stock options, annual bonus, I seem to have extra money coming in every month or two)
3. savings account
4. taxable account
5. HSA ( I keep my receipts)
6. Roth
7. 529 & Coverdell accounts
8. 401k
9. penny jar
10. check couch for loose change
11. sell assets or borrow against them

The order of the last 5 items might not be correct.
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YoungBoglehead
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

Drew31 wrote:
1. Isn't that just mental accounting? You still have 2 months expenses saved to spend. Call it whatever you wish. You've just shrunk the size of cash savings.

2. Sure, logically it sounds great, but what do you do when the things Professor mentions happen? Or something far worse?
1 - I guess you can call it what you want, I'm talking about eliminating the portion used for 'emergencies', and just keeping what you actually need for spending.

2 - What kind of question is that? Given the hypothtical that 2008 happens and you lose your job, what do you do? Well, you transfer enough living expenses out of your investment account to live on. To state it again, my hypothetical situation was that this person has enough in their investment account that even if it were to lose 80% of it's value overnight (very very extreme) they still have enough for 3-6 months living expenses. So, you would just transfer, and live.
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YoungBoglehead
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

mhc wrote:OP,

there are many around here that agree with you. I interpret what you are saying as once your portfolio gets large enough, the need to keep money in the bank diminishes. Personally, I keep ~1 month in my saving account in a local bank. I eventually want to move to half that.

My emergency fund goes like this:
1. credit card
2. cash flow (base pay, espp, rsu's, stock options, annual bonus, I seem to have extra money coming in every month or two)
3. savings account
4. taxable account
5. HSA ( I keep my receipts)
6. Roth
7. 529 & Coverdell accounts
8. 401k
9. penny jar
10. check couch for loose change
11. sell assets or borrow against them

The order of the last 5 items might not be correct.
This is the direction I'm leaning in. I'm trying to make the case for your strategy here. I think it makes the most sense
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sunnyday
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by sunnyday »

I don't think investing is always 100% logic. Peace of mind plays a pretty big role. I keep my disaster fund separate from my retirement portfolio for peace of mind. Maybe I could earn slightly more with it in stocks...will it enable me to retire quicker, no.

Most Bogleheads would agree that stocks are likely to outperform bonds over the long run. Yet, very few are 100% stocks. Is this illogical too?
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YoungBoglehead
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

sunnyday wrote:I don't think investing is always 100% logic. Peace of mind plays a pretty big role. I keep my disaster fund separate from my retirement portfolio for peace of mind. Maybe I could earn slightly more with it in stocks...will it enable me to retire quicker, no.

Most Bogleheads would agree that stocks are likely to outperform bonds over the long run. Yet, very few are 100% stocks. Is this illogical too?
That's a good point, I didn't think about that. Can't put a price on a good feeling, even if it is an illusion.

To answer your second question, I don't know! haha. Good question. Very similar idea honestly, but I have seen threads where people show models where those with bonds outperformed those with 100% stocks
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Drew31
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Drew31 »

I get what you're saying and given a large enough portfolio, you could do what you propose. I just think its a risk story. You're more comfortable with less cash and larger equity investments. I'd prefer having more cash on hand and slightly less in equites.

You're not right and I'm not right and neither of us is wrong. We just have different attitudes toward risk.

I'd just make sure this is something you feel is best not only when the market is reaching new heights, but also when it keeps dropping and you're not sure when it will recover.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by TheTimeLord »

Personally, I keep 12 months in a combination of Money Market and I-Bonds this stability allows me to maintain a more aggressive AA. Thing about disasters the come at some very convenient times.
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YoungBoglehead
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

Drew31 wrote:I get what you're saying and given a large enough portfolio, you could do what you propose. I just think its a risk story. You're more comfortable with less cash and larger equity investments. I'd prefer having more cash on hand and slightly less in equites.

You're not right and I'm not right and neither of us is wrong. We just have different attitudes toward risk.

I'd just make sure this is something you feel is best not only when the market is reaching new heights, but also when it keeps dropping and you're not sure when it will recover.

Doesn't have to be a massive portfolio. Even 40 grand is enough to do my hypothetical. I see what you're saying. Is it really risky though? I mean what exactly are the chances the stock market really loses over 80% of it's value overnight?

Any more than that and it's time to stock up on food and ammo and prepare for the worst lol.

As for the last sentence, I think it's the same risk we all deal with when we choose to invest in ANY stocks in the first place. The whole idea of not having an emergency fund is not as scary to me as just losing money in the first place. I don't really see stocks losing 100% of their value in any realistic setting. Like Bogleheads say, just ride the waves. As long as there's enough in there to survive (in my hypothetical there is, and 40k is even enough so it applies to many of us) than it's all just part of riding the waves and not trying to time the market.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Frobie »

YoungBoglehead wrote: 1 - I guess you can call it what you want, I'm talking about eliminating the portion used for 'emergencies', and just keeping what you actually need for spending.
I'm not seeing the difference. People don't keep an emergency fund to help put out a fire, shut off the main water valve when there's a leak, or to carry them to safety when the plane they are on is going down.

They use it to pay expenses when out of work/sick/whatever. In other words, spending.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by KyleAAA »

All else being equal, I'd say you're significantly more likely to need to cash out your emergency fund when the market is down than when the market is up (you don't tend to see as many layoffs in bull markets).
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

KyleAAA wrote:All else being equal, I'd say you're significantly more likely to need to cash out your emergency fund when the market is down than when the market is up (you don't tend to see as many layoffs in bull markets).
That fact should be irrelevant though in my question/idea. I agree with you, although it doesn't really change anything
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by scotthal »

I think of my portfolio as 80% core - vanilla 60% equities / 40% fixed income; 20% cash & whim (current whim is a mix of VNQ, GE, INTC, ...). Cash position can easily cover short term expenses, & can be creatively stretched to a couple of years. Gotcha is that a market downdraft big enough to get me worried about contingencies would also expose enough buying opportunities that I'd be ... conflicted ... over proper use of the cash.

Bought into the 2008 downdraft (too early), caught a few deals during a subsequent "flash crash". Upside, I'm having fun & not broke (yet).

Disaster fund? Question of contexts - most cases can be covered w/simple liquidity. Market risk doesn't necessarily correlate w/personal circumstance.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by MnD »

Pretty much the same opinion and rough hierarchy as as below. We haven't had a cash emergency fund for 20+ years.
mhc wrote:OP,

there are many around here that agree with you. I interpret what you are saying as once your portfolio gets large enough, the need to keep money in the bank diminishes. Personally, I keep ~1 month in my saving account in a local bank. I eventually want to move to half that.

My emergency fund goes like this:
1. credit card
2. cash flow (base pay, espp, rsu's, stock options, annual bonus, I seem to have extra money coming in every month or two)
3. savings account
4. taxable account
5. HSA ( I keep my receipts)
6. Roth
7. 529 & Coverdell accounts
8. 401k
9. penny jar
10. check couch for loose change
11. sell assets or borrow against them

The order of the last 5 items might not be correct.
70/30 AA for life, Global market cap equity. Rebalance if fixed income <25% or >35%. Weighted ER< .10%. 5% of annual portfolio balance SWR, Proportional (to AA) withdrawals.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by sunnyday »

YoungBoglehead wrote:
sunnyday wrote:I don't think investing is always 100% logic. Peace of mind plays a pretty big role. I keep my disaster fund separate from my retirement portfolio for peace of mind. Maybe I could earn slightly more with it in stocks...will it enable me to retire quicker, no.

Most Bogleheads would agree that stocks are likely to outperform bonds over the long run. Yet, very few are 100% stocks. Is this illogical too?
That's a good point, I didn't think about that. Can't put a price on a good feeling, even if it is an illusion.

To answer your second question, I don't know! haha. Good question. Very similar idea honestly, but I have seen threads where people show models where those with bonds outperformed those with 100% stocks

What sort of models? Are we now backtesting too :) What is the ideal "logic" portfolio?
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by bottlecap »

YoungBoglehead wrote:I think you may have missed part of my original post, I actually cover this situation. I'll quote myself
YoungBoglehead wrote: Using the Bogglehead theory of never timing the market, and assuming you have a decent chunk of investments where even if you took an 80% loss overnight you would still have enough to survive for 3-6 months, should't we keep more invested?
So given the situation where even if we had some massive crash and stock values dropped 80% over night (very extreme) and you still had enough for 6 months living is the question.

This is probably the case for many of us
If you are Warren Buffett, you don't need an EF. But that still doesn't make it market timing.

If you needed $40,000, you'd need to save a $200,000 emergency fund. If the market dropped "as anticipated" and you spent it all, you'd have nothing left and would have to go about rebuilding your $200,000 before investing in a permanent portfolio again. I'd still have $32,000 in investments, hoping it would rebound in 1 to 5 years.

With an EF you are hedging your bets and reducing risk - like holding bonds. If nothing bad ever happens, you do better without an EF. That's math, not logic. But if something real bad does, you are left with nothing. That's risk. I don't think it's logical to treat infrequent situations as impossible scenarios.

JT
Last edited by bottlecap on Wed Dec 04, 2013 12:53 am, edited 1 time in total.
berntson
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by berntson »

YoungBoglehead wrote: Well, let's think about this. Boggleheads of all people should agree that you cannot time the market. We all hope it goes up over time, and that on average it rises, and history shows us it will and we expect it to (on a large scale).
I've been wondering about this myself. Here's a thought experiment I've been kicking around.

Suppose you and I agree to play a game. You give me $10,000. You can then request any amount of your money back once a month. Here's the catch: After you ask for x amount of dollars, I flip a coin. If it lands heads, I subtract x from your account and give you 2x. If it lands tails, I subtract x from your account and give you 1/2 x.

There's no sense in your trying to time the game. Since the coin is fair, you have no idea whether it's going to land heads or land tails when you ask for your money back. But it's still dangerous for you to take all your money out at one time. If you take out $10,000 in one go, there's a 50% chance you'll lose half your money. On the other hand, if you take your money out very slowly (say, $100 a month for 100 months) you'll be almost certain to make money.

Now suppose that your $10,000 is your emergency funds. An emergency could then force you to do something very risky: taking the money out all at once.

I think the market works more or less like that. It randomly distribute overvaluation and undervaluation around a generally upward trend line. The reason that market timing is a bad idea is that it's impossible to know when the market is overvalued and when it's undervalued. But the fact that you can't figure out when the market is overvalued or undervalued does not entail that the market is always fairly valued. If you pull a large amount of money out all at once, there is a good chance the market will be undervalued and that you will not be fairly compensated. If you take the money out slowly, the odds are much better that you will get a fair price.

How much money one should keep out of the market to avoid large sales is a difficult question even on this simple model. It depends on how steep the trendline is and how much the values can deviate from the trendline. It also depends on the size of your portfolio and size of your potential expenses in an emergency.

For what it's worth, my wife and I have all our emergency funds in government bonds. The rest of our investments are in equities. In a crash/unemployment scenario, we sell the bonds and hang on to the equities.
Last edited by berntson on Wed Dec 04, 2013 12:56 am, edited 3 times in total.
Caduceus
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Caduceus »

I think you make good points, but I think others have mentioned before that not everyone needs a dedicated emergency fund. Taylor Larimore has mentioned this on many occasions for instance.

That having been said, some things you might not have considered would be that the protective value of an emergency reserve fund derives in part from the fact that the likelihood of having to draw from it is for many people correlated with downturns in the stock market. In the last crisis, the general stock market decline and job losses meant that people without sizable cash reserves had to sell down just when the prices were plummeting the most. This isn't about pretending that one can time stock market gains/declines but recognizing that liquidity may be most difficult or costly to access when it is most needed. This was true for financial institutions in the aggregate, and also true for many individuals. I think the point about "timing the market" makes more sense if one assumes that your personal liquidity risks are uncorrelated with stock market declines - is this true?

If you can pretty much access cash at low cost even in dire situations, your financial situation is sufficiently flexible that you don't need a dedicated emergency fund; for most people, holding a cash reserve within a stated range makes sense. If yields go up (prices of stocks/bonds go down), the cost of holding cash goes up, and it can then be re-invested.
Last edited by Caduceus on Wed Dec 04, 2013 12:50 am, edited 2 times in total.
castlemodesto
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by castlemodesto »

Many Bogleheads like purchasing IBonds because they are one of the best fixed income investments available. If you have a reasonable amount of IBonds I wouldnt think you would need an emergency fund as the penalty for withdrawal before 5 years is very minimal.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

Hmmm. Well, good input.
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Jebediah
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Jebediah »

OP makes no sense. The sinister side of me likes that this naive sense of equities' risklessness is alive and well. Means there should be some good buying opportunities yet.
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timboktoo
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by timboktoo »

I don't disagree with the concept on paper, provided you know yourself as well as you think you do. I've made the same argument you make many times in my own head. I've taken action on it a few times, too. But every time I have my emergency fund invested I end up going back to cash shortly afterward.

Cash gives me a certain sense of comfort that I'm not aware of until it's gone. Having my emergency fund invested makes me feel more anxious, which is the opposite of what an emergency fund is supposed to do. An invested emergency fund makes me feel trapped in my job, as if I couldn't quit as easily - it's completely irrational anxiety, and yet it's there. It makes me consider having more credit available, even though I promise myself I will just sell from my taxable account. Stretching too far for return makes me feel imbalanced.

As you'll see from the threads below, there are lots of people who do different things with their emergency fund than put it in a savings account. Some people split their e-fund into tiers. Some use their tax-advantaged accounts to hold emergency fund cash, in an effort to increase tax-efficiency.

http://www.bogleheads.org/forum/viewtopic.php?t=52511
http://www.bogleheads.org/forum/viewtop ... 1321410173

I think that the "Keep a 6 month emergency fund in cash" rule could be re-written to say "Have enough money available to handle the bad things that happen in life." It's the spirit of this guideline that matters, not the literal interpretation, and there's a certain amount of social pressure that turns what's more of a guideline into a rule. That said, it's important that you really understand what your goal is with this money.

I've found that I sometimes lie to myself and pretend that I'm asking the question "What's the best way to allocate my emergency fund?" when in reality I'm asking myself "How can I get a higher return with my emergency fund?" I don't need a higher return on my emergency fund for it to serve its purpose. But other things inside of me, such as the desire to keep up with Bogleheads who earn a lot more money than I do, and the desire to seem smart to others, the desire to put my knowledge to work with some sort of action, to continually perfect what's already a perfect portfolio rather than finding a new hobby to satiate my curious brain - these things are what really drive the question and re-shape it instantly in my mind, almost entirely under the radar until I try to get to the root of why the question is so important to me.

So, just be sure that you know yourself. There's a lot more than math involved in what you're proposing.

- Tim
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

Jebediah wrote:OP makes no sense. The sinister side of me likes that this naive sense of equities' risklessness is alive and well. Means there should be some good buying opportunities yet.
Many in here would disagree with you. It's too bad you don't see the sense in it. Doesn't mean it was correct and I had nothing to learn, but pretty surprised it went over your head
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YoungBoglehead
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

timboktoo wrote:I don't disagree with the concept on paper, provided you know yourself as well as you think you do. I've made the same argument you make many times in my own head. I've taken action on it a few times, too. But every time I have my emergency fund invested I end up going back to cash shortly afterward.

Cash gives me a certain sense of comfort that I'm not aware of until it's gone. Having my emergency fund invested makes me feel more anxious, which is the opposite of what an emergency fund is supposed to do. An invested emergency fund makes me feel trapped in my job, as if I couldn't quit as easily - it's completely irrational anxiety, and yet it's there. It makes me consider having more credit available, even though I promise myself I will just sell from my taxable account. Stretching too far for return makes me feel imbalanced.

As you'll see from the threads below, there are lots of people who do different things with their emergency fund than put it in a savings account. Some people split their e-fund into tiers. Some use their tax-advantaged accounts to hold emergency fund cash, in an effort to increase tax-efficiency.

http://www.bogleheads.org/forum/viewtopic.php?t=52511
http://www.bogleheads.org/forum/viewtop ... 1321410173

I think that the "Keep a 6 month emergency fund in cash" rule could be re-written to say "Have enough money available to handle the bad things that happen in life." It's the spirit of this guideline that matters, not the literal interpretation, and there's a certain amount of social pressure that turns what's more of a guideline into a rule. That said, it's important that you really understand what your goal is with this money.

I've found that I sometimes lie to myself and pretend that I'm asking the question "What's the best way to allocate my emergency fund?" when in reality I'm asking myself "How can I get a higher return with my emergency fund?" I don't need a higher return on my emergency fund for it to serve its purpose. But other things inside of me, such as the desire to keep up with Bogleheads who earn a lot more money than I do, and the desire to seem smart to others, the desire to put my knowledge to work with some sort of action, to continually perfect what's already a perfect portfolio rather than finding a new hobby to satiate my curious brain - these things are what really drive the question and re-shape it instantly in my mind, almost entirely under the radar until I try to get to the root of why the question is so important to me.

So, just be sure that you know yourself. There's a lot more than math involved in what you're proposing.

- Tim
Good input. Thanks!!

I guess it will take me going through some version of 08 before I really learn how I can handle the downside of it all. I haven't experienced that yet. I *think* I could just ride the wave but it's all guesses for now!
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by john94549 »

Unclear why anyone would object to having cash in the bank. Having investments of the sort suggested (e.g. equities) is not "either/or". Prudent asset allocations generally have a tad in cash, for example. Conservative asset allocations, a tad more. We have enough for (roughly) twenty years.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by lazyday »

I've never understood the need for an emergency fund, for those with enough Treasury bonds or other very (credit) safe fixed income. Ignoring extremes, like 30 year strips.

Common sense might support a few weeks or more of spending held in banks, in case of a disaster that limits access to other accounts. I like the idea of two accounts with ATM cards; both can be small. Some people like to keep a couple hundred in cash too.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by tibbitts »

This is an interesting post, but it might not have occurred in an environment of 3% inflation and 6% money market yields, or during or immediately after a huge market decline. Everybody is sort of reaching for yield/return at this point, and that's understandable.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Call_Me_Op »

Ahhh, the good old days, when 3-6 months expenses was 5 grand....
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by IlliniDave »

YoungBoglehead wrote:So I've had this thought a few times wanted to get some input. I really think I'm correct here so try to really understand.

The standard procedure is to keep maybe 3-6 months of living money in your bank account to be easily available in case of a disaster, correct?

Well, certain investments, such as ETFs (or something else, commodities maybe) can be moved into your bank account or be turned into cash fairly quickly correct?

Well.. yes, investments can be risky, I could wake up tomorrow and have much much less in my investment account than I do today. This is the reasoning behind a disaster fund. If you lose your job or have some unexpected emergency, the thought is that you don't want to have to remove investments because they could be at a big 'low', correct?

Well, let's think about this. Boggleheads of all people should agree that you cannot time the market. We all hope it goes up over time, and that on average it rises, and history shows us it will and we expect it to (on a large scale)

So intentionally keeping money out of funds for an emergency is almost an equivelant of 'timing the market', sure, the markets could be down during some disaster, however they could also be up. Removing that money and thinking "this is a bad time to remove my money" is the same as thinking "now is a good time to buy, the market is low" or "I should sell now, the market is high"


Using the Bogglehead theory of never timing the market, and assuming you have a decent chunk of investments where even if you took an 80% loss overnight you would still have enough to survive for 3-6 months, should't we keep more invested?

Why keep 3-6 months (which could easily be 5 grand) sitting in a bank account when you could have 3 grand of that invested? Keeping it out for fear of removing stocks at a low point is market timing. Just keep enough in the bank to pay for your rent, expected monthly expenses, and invest the rest.


Makes sense, right? -and for the record, I currently keep 3-6 months of savings in my bank account. Just want to share this idea
Some quick-to-mind thoughts.

*The argument for a cash reserve really isn't a purely logical (or more accurately mathematical) one. The problem with running one's personal finances completely on math with the "goal" being to accumulate as much money as possible is that it puts one on a slippery slope to some risky behaviors. Here in America, we have a right to take those risks. But it's prudent to understand them. A large component of how humans deal with risk is emotional/instinctual rather than logical/mathematical.

*Having seen what happened to people I know who took it to the extreme--no cash reserve and hit simultaneously with an upside down mortgage, devastated investment portfolio, and extended loss of employment--just 5 short years ago makes me substantially more conservative in my outlook. It really can come unglued.

*There's also a behavioral aspect of it. It's difficult to set aside money for the very long term. If part of your plan calls for getting into your nest egg every time the car breaks down or the roof leaks, then it becomes easier to rationalize raiding it for the luxury vacation you didn't bother to save for or the Harley Davidson you decided you wanted when you noticed your hair thinning. Not all people are susceptible to that, but be sure you know yourself well.

*It wasn't so long ago that a person could expect a small real return in a money market fund or a CD, so cash wasn't as much of a losing proposition as it is at this moment.

*There are some compromises one might take. If it just kills you to hold cash you could put some of your reserve into short-term treasury bonds. You won't make a ton of money but the principal will stay pretty stable and you'll offset some inflation. I actually do this myself with 3/4s of my 1-year emergency fund.

*If you've got a supersized portfolio it probably doesn't matter (Bill Gates probably doesn't "need" a dedicated emergency fund).

*People can and do get by with little or no cash holdings. I've yet to see a bona fide financial expert "recommend" that approach (but I don't scour the universe of authorities with great dedication). I suspect there's reasons for that.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by rkhusky »

berntson wrote: For what it's worth, my wife and I have all our emergency funds in government bonds. The rest of our investments are in equities. In a crash/unemployment scenario, we sell the bonds and hang on to the equities.
+1
We don't have a separate emergency fund, but for emergencies we keep a portion of our fixed income in muni bonds in a taxable account. We have some short term and some intermediate term - enough to cover a year's worth of expenses (maybe two if we get extremely frugal). We do keep a small amount in cash to smooth out the variation in expenses that occur through the year.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by TheTimeLord »

lazyday wrote:I've never understood the need for an emergency fund, for those with enough Treasury bonds or other very (credit) safe fixed income. Ignoring extremes, like 30 year strips.

Common sense might support a few weeks or more of spending held in banks, in case of a disaster that limits access to other accounts. I like the idea of two accounts with ATM cards; both can be small. Some people like to keep a couple hundred in cash too.
It is a good thing no one ever loses their job during an economic downturn when the market is tanking and is forced to sell near the bottom after 9 months of unemployment. I once read a recommendation from a group of investors with at least $10 million in investable assets. The recommendation was to always have 3 years of living expenses in a very liquid form so you could ride out any downturn without being forced to liquidate. Obviously you would need a sizable portfolio to do this but their point was undesrtandable. I also think believing credit cards are a first option in a true disaster is sowing the seeds of financial ruin.
Last edited by TheTimeLord on Wed Dec 04, 2013 9:33 am, edited 1 time in total.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by wedsep »

I view "disaster fund" as part of asset allocation, in stable value category set by absolute amount instead of percentage.

When market is unfavorable and you need fund, you take it from stable value. When market is climbing, you can take from taxable account. How much "disaster fund" is comfortable is up to you, just like some people set 50% bond and some set at 20%.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by bayview »

YoungBoglehead wrote:
KyleAAA wrote:All else being equal, I'd say you're significantly more likely to need to cash out your emergency fund when the market is down than when the market is up (you don't tend to see as many layoffs in bull markets).
That fact should be irrelevant though in my question/idea. I agree with you, although it doesn't really change anything
It's not irrelevant at all! When do you think you're most likely to get downsized or laid off? When the market is booming, or when everything is collapsing, no one is buying, no one is hiring? If that happens, and your 1000 shares of some stock fund that used to be worth $10K is now worth $5K, you'll have to sell many many more shares to create the same cash as before a market drop.

Sure, there are times you have to hit your emergency fund (I prefer that term to "disaster") due to non-job-related personal reasons, like a bad car wreck that involves a temporary loss of income and uncovered medical expenses, but you really need to think about interruptions in employment. Those who were once fully employed and salaried but lost their jobs for whatever reasons are now frequently looking at less-than-fulltime, fewer or no benefits, possibly "contractor"-type jobs. There has been a huge drop in the standard of living for many in the middle class (including tech types) and the blue-collar working class, because lost jobs aren't being replaced at the same level of pay and benefits.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Grt2bOutdoors »

Experience is a harsh task master. Get your hands on a copy of The Great Depression by Benjamin Roth. You will soon see the errors of your challenge. One learns the true value of money when they need to borrow it. Debt is the shackles of the free, if you want to be free - avoid debt.

My e-fund: 6 months in a savings account - very liquid, very accessible, decent (rolling my eyes) interest rate.
6 months in a breakable CD - much higher rate of interest, semi-iiquid, insured.
1.5 years in low rate I bonds - if I need it, it's there. If I don't need it, it is part of fixed income.
Everything else in my portfolio - up for grabs if I need to sell.
Last edited by Grt2bOutdoors on Wed Dec 04, 2013 9:51 am, edited 1 time in total.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by mhc »

People's circumstances are different. I agree that layoffs and bad market are likely to happen at the same time. I'm not sure a 3-6 month EF is going to make much difference if you are out of work for 5 years and your portfolio is cut in half.

For me, if I get laid off, I will walk with over 6 months pay. That is enough to live on for a year. I will also collect unemployment. That will help also. Even if my portfolio is cut in half, I could live on it for a long time. I would then have to stay in the workforce longer, but an additional 6 months of cash is not going to change things much. Also, I have no debt. I could live really cheaply if need be. Instead, I chose to keep my money invested. This way I have a larger portfolio that gets cut in half if the market crashes.

I can see that a larger EF makes sense for people with fewer liquid assets or need it to sleep well at night. I know I liked having cash in 2009.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Grt2bOutdoors »

StarbuxInvestor wrote:
lazyday wrote:I've never understood the need for an emergency fund, for those with enough Treasury bonds or other very (credit) safe fixed income. Ignoring extremes, like 30 year strips.

Common sense might support a few weeks or more of spending held in banks, in case of a disaster that limits access to other accounts. I like the idea of two accounts with ATM cards; both can be small. Some people like to keep a couple hundred in cash too.
It is a good thing no one ever loses their job during an economic downturn when the market is tanking and is forced to sell near the bottom after 9 months of unemployment. I once read a recommendation from a group of investors with at least $10 million in investable assets. The recommendation was to always have 3 years of living expenses in a very liquid form so you could ride out any downturn without being forced to liquidate. Obviously you would need a sizable portfolio to do this but their point was undesrtandable. I also think believing credit cards are a first option in a true disaster is sowing the seeds of financial ruin.
+1 Very sound advice. Most HNW investors have substantial liquidity, don't kid yourself - even the hedge fund gurus don't have all of their net worth tied up in illiquid or semi-illiquid investments. You only know who's been swimming naked when the tide rolls out - Warren Buffett.
If Berkshire died a sudden death tomorrow, do you think Warren has only a $1 in his pocket or $100 million in Treasuries? My bet is on the latter and not the former. It's called common sense.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Chadnudj »

Keep in mind, there is a lot more to factor in here in case of an emergency like a job loss:

- How likely is it for you to experience job loss? (Jobs vary in their susceptibility to job loss, for a variety of factors)
- How likely is it that you could quickly find a new job? (again, certain jobs can quickly find replacement positions, even if at slightly less money)
- What portion of your expenses could be/would be covered by unemployment?
- What portion of your expenses could be/would be rapidly cut in the event of a job loss? (i.e. you can quickly cut cable, eating out, making extra payments on mortgate/debt, etc., all of which would extend the life of your emergency fund, regardless of where it is held; some people could even get a roommate, or move back in with parents if they lost their job, or sell a car, etc.)
- Does your spouse work, and if so, what portion of the expenses can they cover? (This was a savior when I lost my job - my wife still had hers, we could live on her salary alone, so I lost almost nothing in nearly 3 months of unemployment)
- Could you pick up some side-hustle type jobs while looking for a job? (Every little bit helps)
- What do you have that you could sell quickly and easily for money that would be better than selling stocks in an emergency fund that might have gone down rapidly? (i.e. gold, electronics that would get a decent return, used books, etc.)
- Do you have access to cheap credit, such as a HELOC? (In which case, you might be better off taking out money from a HELOC vs. selling investments that have gone down a lot, if the job loss will only likely be temporary)

I don't think there is a right or wrong answer on what to do with your emergency fund, and I can see the case for investing a lot of it in an investment account to let it work for you. It just depends on your risk tolerance and the effect a serious emergency like a job loss would have on you in light of factors such as those listed above.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Grt2bOutdoors »

Chadnudj wrote:Keep in mind, there is a lot more to factor in here in case of an emergency like a job loss:

- How likely is it for you to experience job loss? (Jobs vary in their susceptibility to job loss, for a variety of factors)
- How likely is it that you could quickly find a new job? (again, certain jobs can quickly find replacement positions, even if at slightly less money)
- What portion of your expenses could be/would be covered by unemployment?
- What portion of your expenses could be/would be rapidly cut in the event of a job loss? (i.e. you can quickly cut cable, eating out, making extra payments on mortgate/debt, etc., all of which would extend the life of your emergency fund, regardless of where it is held; some people could even get a roommate, or move back in with parents if they lost their job, or sell a car, etc.)
- Does your spouse work, and if so, what portion of the expenses can they cover? (This was a savior when I lost my job - my wife still had hers, we could live on her salary alone, so I lost almost nothing in nearly 3 months of unemployment)
- Could you pick up some side-hustle type jobs while looking for a job? (Every little bit helps)
- What do you have that you could sell quickly and easily for money that would be better than selling stocks in an emergency fund that might have gone down rapidly? (i.e. gold, electronics that would get a decent return, used books, etc.)
- Do you have access to cheap credit, such as a HELOC? (In which case, you might be better off taking out money from a HELOC vs. selling investments that have gone down a lot, if the job loss will only likely be temporary)

I don't think there is a right or wrong answer on what to do with your emergency fund, and I can see the case for investing a lot of it in an investment account to let it work for you. It just depends on your risk tolerance and the effect a serious emergency like a job loss would have on you in light of factors such as those listed above.
Don't count on a HELOC - the very first thing the banks did were to cut the lines to conserve their regulatory capital. Even credit card lines were cut.
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