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

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

Post by The Wizard »

Job loss is the key thing, yes.
I'm retired now, but was fortunate never to be unemployed during my 41 years of employment.
I never had an emergency fund: I used extra cash to pay down loans, to increase my savings rate, and to spend with wild abandon.
I did have the ability to borrow up to $50,000 against my 403(b) if needed and I did use that line of credit two times.

So if you're confident in your employment security, yes, go for it...
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KyleAAA
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by KyleAAA »

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
You say "you could sell out when the market is down, but you could also sell when the market is high." That's technically true, but you're much more likely to be selling out when the market is down. Therefore, an emergency fund isn't a form market timing because you know that IF you need it, it will probably be when the market is down. It's not a 50/50 split and your needs are random or independent of the market. The only way this would be akin to market timing is if the average emergency fund dollar you needed to withdraw came at RANDOM intervals INDEPENDENT of the direction of the stock market. Since that isn't likely to be the case, the analogy doesn't hold.

One exception I would agree with is that if you have a large enough taxable portfolio (say $100k+) you're probably fine dispensing with a cash emergency fund because you're probably safe from any foreseeable setback.
Last edited by KyleAAA on Wed Dec 04, 2013 10:17 am, edited 2 times in total.
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TheTimeLord
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by TheTimeLord »

The Wizard wrote:So if you're confident in your employment security, yes, go for it...
There are very few people in the world that should be able to answer yes to that if they are realistic. Having watched my share of layoffs, which I was never caught up in, the rearely have rhyme or reason when happening to sizable numbers of employees.
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M_to_the_G
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by M_to_the_G »

The OP has thought long and hard about this issue, about every possible eventuality under every potential circumstance, and has concluded that he doesn't need an emergency fund.

Have you ever seen the movie "Contact?" There's this great scene where Jodie Foster's character is given a cyanide capsule before she goes through a wormhole in space where no one knows where the wormhole leads to or what awaits her at the end of the wormhole. They give her the capsule, and she is told that the capsule is not for the situations they have thought of; rather, it is for the situations they haven't thought of.

I am a tenured fed. I have a six figure portfolio and good income. I have no dependents, no one who would need my help (or rather, no one who would get my help), no health issues, and nothing else I can think of that might lead to an unexpected and catastrophic disaster where I would need immediate liquidity in the form of cash to deal with it.

Aaaand that's precisely why I have an emergency fund. For all the things I can't think of. What could possibly happen? I don't know. I've thought of everything... and that's why I have an emergency fund.
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HomerJ
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by HomerJ »

When are you more likely to lose your job?

During a recession when stock prices are dropping? Or during a boom time when stock prices are rising?
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HomerJ
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by HomerJ »

timboktoo wrote: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.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by The Wizard »

StarbuxInvestor wrote:
The Wizard wrote:So if you're confident in your employment security, yes, go for it...
There are very few people in the world that should be able to answer yes to that if they are realistic. Having watched my share of layoffs, which I was never caught up in, the rearely have rhyme or reason when happening to sizable numbers of employees.
I believe you are correct.
So the OP needs to ponder this and come up with a plan.
Can he move back in with the parents if the need arises?
Or is he (going to be) married with a spouse who has similar employment income, but in a different job type?
One size doesn't fit all for this question...
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Gamedaymusings
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Gamedaymusings »

Call_Me_Op wrote:Ahhh, the good old days, when 3-6 months expenses was 5 grand....
This is the central idea that many seem to be overlooking.

Why does are to retirement AA pass for common sense but not apply to an E fund?

Monthly expenses are such a subjective amount that the size differences of everyone's relative fund could be huge. 5 grand? Could be 10 grand or more for some.

Because monthly expenses are a real number, not some one-asset-ratio-fits-all, we're comparing apples to crates of apples here.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by barnaclebob »

I don't have a dedicated emergency fund in the bank but my taxable investments are more conservative than they would be if i had one. If I have to tap into my taxable investments then it might just mean waiting a little longer to upgrade to a better house or I might have to get an older car when my current one craps out.
Rodc
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Rodc »

A disaster fund is most important for someone who has little money in taxable investments. If what little they have in taxable is in stocks the market tanks, economy tanks, they lose their job, they may not have enough in stocks to sell if down, or might have to take out a 401K loan, etc. If instead your taxable account is in muni bonds or something this is much less of an issue. I'm not sure that people who believe in emergency funds would quibble too much about high quality bonds vs "cash".

If you have a large taxable portfolio this is not really as much of an issue or perhaps an issue at all. Over the years you will likely be up enough vs being invested in cash that even if you have to sell some in a down market you might still be up.

On the other hand, "cash" is a legitimate asset and it probably makes sense for most people to have some of their fixed income allocation in cash regardless of emergency fund or no emergency fund.

Indeed standard portfolio construction says to hold a cap weight portfolio of risky assets (ie stocks and bonds) diluted with cash (so called riskless asset, often taken to be something like 30 T-Notes) to your preferred level of risk, in which case this is a non-issue.

If you prefer you can hold the cash in a 401K with a matching amount of stocks in taxable, and if you need cash you sell stocks in taxable and buy a like amount in your 401K from your 401k cash allocation.

2008 or so should give pause to anyone counting on a HELOC or credit cards to cover in an emergency.
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Phineas J. Whoopee
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Phineas J. Whoopee »

Hi YoungBoglehead,

I've read the thread (60 posts anyway, somebody else may be composing as I type). I'm going to bring up something that has appeared in a few of the responses, but I'll say it in a different way.

To begin with, let me make it clear I'm not trying to convince you of anything. I'm content if we disagree, and fully support that you manage your own finances in the way that to you seems best.

What I am doing is responding to your logic-only, emotion-free reasoning.

I'll start with a rhetorical question: With respect to your finances, what are you trying to accomplish? Without putting words into your mouth, I'm going to surmise it's maximum growth of wealth. Why? Because your reasoning makes sense if one is aiming to achieve that and nothing else, and in service of the goal is willing to accept adverse consequences should they arise.

Strikingly absent from your logic is any consideration of risk. Even when raised by those you asked to comment on your thoughts you simply dismiss it, repeating from your OP ridiculous things like if one's entire portfolio dropped by 80% overnight one would still have three to six months worth in assets. If one's portfolio dropped 80%, overnight or otherwise, and one was broadly diversified like a Boglehead, terrible things would be happening in the wider world and they would affect your circumstances. There would be rent forbearance. There would be public distributions of food. You might be able to access medical care for a true emergency. If you went to the dentist with any problem it would probably be treated with a quick extraction. There would be hunger. There would be epidemics. There might well be a war raging on our shores, not somebody else's. Our nice comfortable advanced-economy world would have changed.

So now, let me ask another rhetorical-sounding question, except it's about me and I'll answer it: What am I trying to accomplish?

I am trying to come to a point where I can, without freshly-earned employment income, meet my own future financial needs and, within reason, wants, without taking undue risk.

It's the "without taking undue risk" intention that makes your logic-only, emotion-free reasoning inapplicable to my situation. I suspect I'm not alone, but I won't try to speak for anybody else.

PJW
Last edited by Phineas J. Whoopee on Wed Dec 04, 2013 12:36 pm, edited 2 times in total.
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Raybo
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Raybo »

How much "extra" return are we talking about here?

Let's say a 3-6 month emergency fund is $20,000. At 3% real return, that would be $600 a year in "extra" income. Assume state and local taxes of 33% and it drops to $400 a year.

So, that is the kind of "big" money we are talking about here. What is the trade-off you are making for that extra $400. Should you need the money due to some non-personal disaster (i.e. 9/11, or Katrina), the market will be down as a result and the $400 gains in your emergency fund will evaporate quickly.

In truth, the value of my portfolio is constantly changing and the "return" I get is wholly dependent on when I withdraw money from my investments. The more control I have of when I sell my stocks, the better able I will be to take profits. Without any cash "buffer," I would have sell when I needed money, not when it was in my best interests.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by crswvc »

IlliniDave wrote: *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.
Betterment (financial expert?) does recommend exactly this: https://www.betterment.com/blog/2013/08 ... -is-wrong/
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Phineas J. Whoopee
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Phineas J. Whoopee »

crswvc wrote:
IlliniDave wrote: *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.
Betterment (financial expert?) does recommend exactly this: https://www.betterment.com/blog/2013/08 ... -is-wrong/
Standard Boglehead wisdom. There's even a wiki page. If you keep your emergency reserve in risky assets like equities, put in at least twice as much value as you anticipate needing under whatever heuristic you've chosen.
PJW
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by MoonOrb »

OP,
I'm with you in practice, not so sure I follow (or care about) the "timing the market" justification you use for it. The only thought I have is that the more precarious your financial position, the more you should tilt toward the conventional wisdom of keeping your E-fund in safer investments. The less precarious your position, the more risk you can afford to take.

For instance, I would be really grumpy if there were some kind of catastrophe that caused me to liquidate some of my taxable holdings at a big loss, but I can't imagine any situation so bad that they would drop so low that I couldn't come up with funds in an emergency.

Other folks might be in a different position--either because they don't have as much in taxable holdings that can be liquidated, or because the likelihood of an "emergency" putting them under financial stress is much greater.

Or, another way I think about this is that it's not as necessary to have an "emergency fund" as it is to have an "emergency plan." One of the things you think about in preparing your emergency plan is the likelihood of needing to put it into action, and the other is what your tolerance for the true downside risk is.

In my emergency plan, the worst case scenario would be having to liquidate taxable holdings at a huge loss--but even doing this would leave me with a year or more of expenses covered. Would I be okay with this? I think so, because it still wouldn't require me to touch anything in my tax-deferred accounts, which make up 85% of my investments.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Sriracha »

When it comes to emergency funds, I'm an old fuddy-duddy (ok, a middle-aged fuddy-duddy) and just can't shake the idea that having a relatively traditional EF is the right thing for me.

After going through the tech and financial busts and remembering how awful I felt when I was just starting out and didn't have a pot to p#@* in, the warm fuzzies I get from seeing those EF assets ready, willing and able to meet our expenses when times are getting sketchy always ends up trumping the urge to reach for something that yields more. The tiered EF is as far as I'm likely to go. If that falls within someone's definition of "active," I can live with that -- even though I strive to be Bogleheadish. At that level, it's all semantics to me, anyway.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Rodc »

How much "extra" return are we talking about here?

Let's say a 3-6 month emergency fund is $20,000. At 3% real return, that would be $600 a year in "extra" income. Assume state and local taxes of 33% and it drops to $400 a year.
This is a very good point. Magnitude matters. Don't sweat the small stuff.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by ruralavalon »

I put about one month's expenses in the checking account at the start of each month.

We have a joint taxable account invested in stock index funds, no cash at all except when dividends have just been paid, large enough to fund living expenses for about 3 1/2 years. Sure, that might mean selling when the market is down, but it also might mean selling when the market is up. Is that an emergency fund?

All of our other investments are very liquid, meaning that they could be turned into cash in the checking account in a couple of days. Sure, that might mean selling when the market is down, but it also might mean selling when the market is up. Is that an emergency fund?

I have a high limit credit card I never use, and another card we use but pay off every month, the limit's high enough we could live on it for about two years. Is that an emergency fund?

We have never had a dedicated "emergency fund" or similar account, nor a large pile of cash or its equivalent anywhere.

Had an extremely variable income, sometimes fluctuating by 400% from one monrh to the next, or by 100% from one year to the next. "Extra" money always went into additional investing.
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Clearly_Irrational
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Clearly_Irrational »

An emergency fund isn't timing the market, it's risk management. A preference for a highly liquid low risk asset makes sense when you're talking about funds with a high time sensitivity.

For me, I try to consider a very nasty scenario:

1) I lose my job
2) My tenants stop paying their rent (possible if the economy really tanks and they lose their jobs as well, although it didn't happen last time)
3) The market crashes 50% (most crashes are this size)
4) I end up unemployed 4x as long as is normal for my profession (it usually takes about three months to find something new)
5) At least one of my financial institutions either collapses (bank failure?) or is discovered to be involved in malfeaseance (MF Global?)
6) Several of my credit lines are significantly reduced or canceled

In general, you won't realize it's a crisis right away so I try and leave myself about three months to figure out that things are going down the tubes in addition to the above.

Not all of the money needs to be in bank deposits, but it does need to be readily accessible, so for example ROTH IRA accounts would qualify (principal only and subject to items 3 & 5), but my 401k would not (you can't even take a loan on it if you're unemployed and cashing it out would be extremely painful tax wise). CDs and directly held t-bills would count (adjusted for early withdrawal penalties and subject to item 5). Credit cards and Helocs would count (subject to item 6). Taxable investments would count (subject to items 3 & 5).

So, to wrap all of that up ideally I'd like around fifteen months worth of expenses (not income), however after you apply items 3, 5, & 6 you're actually looking at closer to thirty months worth. (depending on how much you've spread your money around and which types of assets it's composed of)

I'm not there yet but I'm working on it.
downshiftme
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by downshiftme »

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?
I suspect this idea is gaining traction not so much because of the market gains, but because of the disparity between bank account savings rates (sub 1%) and market gains this year (maybe 20%). It doesn't take many years of that before such a scheme pays for itself. Whether we will get those years is unknown, but even with lesser disparity, the effect still happens.

Part of the problem may also lie in defining what kinds of emergencies this disaster fund is supposed to cover. I have never encountered an urgent need for house repairs or car replacement that needed 3-6 months cash infusion with no notice or financing opportunity. Likewise, while I've suffered through several layoffs and economic downturns, sometimes at the same time, I've not found employment impossible to secure for years at a time. Am I still trying to protect against that? What about a real depression or social upheaval on a scale not seen in my lifetime? If I'm trying to protect against these 100-year or 500-year flood possibilities, then maybe my emergency fund strategy is different.

In my experience a month or two of expenses in cash has always been enough to cover any unexpected urgent need. A larger investment in my taxable portfolio has been enough of a backstop for peace of mind during loss of employment. Credit and frugality has been sufficient to smooth out any other emergency spending needs. Given that, my keeping the bulk of my "disaster fund" invested for several decades means it has grown to multiples of what it would have been if I had only held it in ready cash equivalents. I see this as a win and even if I am forced to liquidate during a future market downturn I will likely still be far ahead by investing this way.

Now if I'm actually trying to protect myself in case of a 500-year or 1000-year disaster, then my plan will be woefully insufficient. But then protection for those kinds of events likely involves more than just financial considerations.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by IlliniDave »

crswvc wrote:
IlliniDave wrote: *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.
Betterment (financial expert?) does recommend exactly this: https://www.betterment.com/blog/2013/08 ... -is-wrong/
Well, okay, but I'm inherently skeptical of accepting personal finance advice from for-profit businesses that want to sell me investment products/services, so they wouldn't make my cut of who I'd consider bona fide financial experts. I see TV commercials frequently that tell me I should by gold coins from them for my rainy day fund, and I don't count them as experts either. I understand there are people who espouse the stock market approach, and that one can make a mathematical argument to support it. But it goes contrary to the school of advice I follow and look to for guidance. I mentioned I didn't turn over every rock out there, meaning largely that my "research" exists in a limited universe of essentially traditional person finance.

But there's many ways to skin a cat. :D
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hand
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by hand »

bottlecap wrote: If you are Warren Buffett, you don't need an EF. But that still doesn't make it market timing.
In point of fact Warren Buffett explicitly prefers to keep an emergency $20B on hand at Berkshire Hathaway, and presumably does the same in his personal life.

http://www.theglobeandmail.com/report-o ... cle626726/
http://www.berkshirehathaway.com/letters/2010ltr.pdf (see pages 22 & 23)

Also, note this interesting commentary on Buffett's view on cash:

http://blogs.marketwatch.com/thetell/20 ... rs-report/


I have no doubt that the OP is correct that on average, no emergency fund comes out ahead, but the purpose of an emergency fund is not to win on average, it is to ensure that you don't lose when real life is less than average.

Edited to add page reference to BRK Shareholder letter
generalzodschicken
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by generalzodschicken »

Call_Me_Op wrote:Ahhh, the good old days, when 3-6 months expenses was 5 grand....
In NYC that's called "rent."
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by goblue100 »

YoungBoglehead wrote: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!
First, I'd like to say you are ahead of most people your age just by knowing enough that you should have an emergency fund. I've read most of the replies and I would say most of the pro's and cons of keeping cash on hand have been covered. Mine own commetn would be when the sky is falling, and I most certainly thought it was in 2001 and 2008, I'd rather be a buyer than a seller.

Second, per your comment above, I'd like to reccomend a book:
Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich by Jason Zweig

There are many other book on the psychology of money and investing, but I've read this one and got some pretty good insights into myself.
Financial planners are savers. They want us to be 95 percent confident we can finance a 30-year retirement even though there is an 82 percent probability of being dead by then. - Scott Burns
thx1138
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by thx1138 »

You are getting disparate answers because the participants are in different phases of their portfolios.

Here is the crux and what I think you and some others are missing: A "disaster fund" is really a "unexpected distribution portfolio".

Read up on how portfolios are designed for accumulation and distribution phases. The very coarse and primitive rule of thumb being "age in bonds". Distribution portfolios are structured as they are because funds are steadily being removed over time, these withdrawals being mandatory and with no opportunity to every put in more money - you can never recover from a sudden drop in portfolio value. Accumulation portfolios on the other hand can be structured very differently since money is instead flowing into them continuously with no required withdrawals - you actually benefit in the long term from a sudden drop in portfolio value.

Consider the reaction of two people to an 80% drop in equities while holding a 100% equities portfolio.

If you are in the accumulation phase you think "Hurray, I get to buy so many cheap stocks as I continue to put money into my retirement accounts and I don't have to sell any. In fact if it stays this low for three years I get to buy gobs and gobs of cheap stocks that will increase in value a lot before I retire and I may get to retire early."

If you are in the distribution phase you think "Oh poop, for just this one year of expenses I now have to withdraw the equivalent of five years of my original portfolio plan. If things stay this way for three years I will have consumed 15 years of my portfolio. And there is no way for me to ever recover the loss on those withdrawn funds."

In short, plummeting equities prices are great news for an early accumulator and death for a distributor.

What is a "disaster fund" really for then? It is for when you suddenly must start distributing when you hadn't planned to. If you are an early accumulator and suddenly have to start distributing then you are actually all of a sudden like a retiree but you don't have the correct portfolio for that. So your "disaster fund" is really a distribution portfolio held in reserve. On the other hand, if you are already a retiree then you don't care as mush as you are already structured to take distributions. Hence no need for a "disaster fund" for a person already with a distribution portfolio.

You can see in this context then that the more aggressive the portfolio the more the need for the disaster fund. As others pointed out if you have a more conservative fund then the FI portion of your portfolio is in a sense provided part or even all of your "disaster fund".

The flaw in your original logic is the same flaw that says you should leverage 100% equities by 4:1 if at all possible. Your portfolio is not "the average". Maximizing the "average" return is not the goal. Minimizing the worst case return (over the relevant time period) is. It is this principle that leads to the different construction of accumulation and distribution portfolios and it is the reason anyone in the accumulation phase needs to have a "disaster fund" of some form - its exact implementation not being critical.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Professor Emeritus »

YoungBoglehead wrote:
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?

Sure sounds like "I consider it self-defeating to plan in terms of retreat." from the Eiger sanction.
It's like putting on your seatbelt.
You don't FOCUS on the worst case but you do PREPARE for disaster.
I buy insurance too.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by englishgirl »

I suppose my question is: do you really want a "disaster" fund, an "emergency" fund, or a "slush" fund?

I've always used my cash emergency fund as a slush fund. The car suddenly needs an expensive repair? That's a job for the slush fund. New A/C unit? Also slush fund. Can't cover the bills this month because my self employment income has dipped? Also slush fund. I don't think I'd want to be buying and selling stocks constantly to act as a slush fund, as it would generate taxable events. Cash really is a lot more fluid and easily movable in those circumstances.

I *do* have a second tier of emergency funds in I-bonds. I thought I'd keep them for big emergencies. I used to have a taxable investment account, where I had the tuition money for my master's degree program. I thought I'd keep the money in there in stocks to earn more return up until the time I needed to use the money. But here's the thing. I started my master's program in January 2009. I watched the value of that account tank (because of course it was 100% in stocks) right before I needed it. And keep going down. At the same time, my I-bonds were a shining star, as they were earning over 2% real. There was no freakin' way that I was going to sell those I-bonds unless I absolutely had to. So, I didn't want to sell my stocks as they were way down, and I really wanted to hang on until the value came back up, and I didn't want to sell I bonds as they were the only thing that was doing well. And therefore I felt totally stuck. Now, as it happened, I had that cash slush fund, and it turned out that my college accepted monthly payments via credit card without charging extra fees. So I muddled my way through. I had to sell some of the stocks when they were down, but not all.

The purpose of this post is to say…don't discount what your emotions are going to be doing. If you face a situation where stocks are really down, you will be resistant to sell. Especially if that's a moment when you are suffering from job loss at the same time or something and don't have any additional cash somewhere.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by berntson »

Truth be told, 6 months of living expenses is such a small amount of money (from the standpoint of a lifetime worth of investing) that it probably just doesn't matter. There's a good chance that you'll lose money if you're forced to withdraw when the markets are down. There's also a good chance that investing emergency funds in equities will, over time, make up for those losses. The main thing is to find a plan you like and stick with it when things turn bad.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

M_to_the_G wrote:The OP has thought long and hard about this issue, about every possible eventuality under every potential circumstance, and has concluded that he doesn't need an emergency fund.

Have you ever seen the movie "Contact?" There's this great scene where Jodie Foster's character is given a cyanide capsule before she goes through a wormhole in space where no one knows where the wormhole leads to or what awaits her at the end of the wormhole. They give her the capsule, and she is told that the capsule is not for the situations they have thought of; rather, it is for the situations they haven't thought of.

I am a tenured fed. I have a six figure portfolio and good income. I have no dependents, no one who would need my help (or rather, no one who would get my help), no health issues, and nothing else I can think of that might lead to an unexpected and catastrophic disaster where I would need immediate liquidity in the form of cash to deal with it.

Aaaand that's precisely why I have an emergency fund. For all the things I can't think of. What could possibly happen? I don't know. I've thought of everything... and that's why I have an emergency fund.

Love that movie and do remember that scene. I see what you're saying. Peace of mind is a big deal.

I also have a large portfolio and 6+ figure income and only depend on myself, my thinking was that even if 2008 happened again I could still transfer enough money out to survive and keep it invested, but there have been some good points in this thread & I think I'm reversing that idea
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

Phineas J. Whoopee wrote:Hi YoungBoglehead,

I've read the thread (60 posts anyway, somebody else may be composing as I type). I'm going to bring up something that has appeared in a few of the responses, but I'll say it in a different way.

To begin with, let me make it clear I'm not trying to convince you of anything. I'm content if we disagree, and fully support that you manage your own finances in the way that to you seems best.

What I am doing is responding to your logic-only, emotion-free reasoning.

I'll start with a rhetorical question: With respect to your finances, what are you trying to accomplish? Without putting words into your mouth, I'm going to surmise it's maximum growth of wealth. Why? Because your reasoning makes sense if one is aiming to achieve that and nothing else, and in service of the goal is willing to accept adverse consequences should they arise.

Strikingly absent from your logic is any consideration of risk. Even when raised by those you asked to comment on your thoughts you simply dismiss it, repeating from your OP ridiculous things like if one's entire portfolio dropped by 80% overnight one would still have three to six months worth in assets. If one's portfolio dropped 80%, overnight or otherwise, and one was broadly diversified like a Boglehead, terrible things would be happening in the wider world and they would affect your circumstances. There would be rent forbearance. There would be public distributions of food. You might be able to access medical care for a true emergency. If you went to the dentist with any problem it would probably be treated with a quick extraction. There would be hunger. There would be epidemics. There might well be a war raging on our shores, not somebody else's. Our nice comfortable advanced-economy world would have changed.

So now, let me ask another rhetorical-sounding question, except it's about me and I'll answer it: What am I trying to accomplish?

I am trying to come to a point where I can, without freshly-earned employment income, meet my own future financial needs and, within reason, wants, without taking undue risk.

It's the "without taking undue risk" intention that makes your logic-only, emotion-free reasoning inapplicable to my situation. I suspect I'm not alone, but I won't try to speak for anybody else.

PJW
This was actually my exact point with the '80% drop' comment I made. I realize that if stocks lost that amount this would be the case, that's why I used that extreme amount, to somewhat make the point that as long as you have a decent sized portfolio, even if a 2008 happens you'll have enough to withdraw the taxable account and pay for expenses.

You are correct in ultimate goal to increase wealth, although I don't want to dismiss risks. My idea is that it doesn't increase risk to do this but that's why I made the thread, because I usually have a lot to learn from posters here
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

Raybo wrote:How much "extra" return are we talking about here?

Let's say a 3-6 month emergency fund is $20,000. At 3% real return, that would be $600 a year in "extra" income. Assume state and local taxes of 33% and it drops to $400 a year.

So, that is the kind of "big" money we are talking about here. What is the trade-off you are making for that extra $400. Should you need the money due to some non-personal disaster (i.e. 9/11, or Katrina), the market will be down as a result and the $400 gains in your emergency fund will evaporate quickly.

In truth, the value of my portfolio is constantly changing and the "return" I get is wholly dependent on when I withdraw money from my investments. The more control I have of when I sell my stocks, the better able I will be to take profits. Without any cash "buffer," I would have sell when I needed money, not when it was in my best interests.
To summarize what you're saying (I think), basically you're saying the payoff of having the ER fund invested is not worth the risk. My reply is that, even though you say it's a small amount, it adds up just like every dollar. If you chose to invest the ER fund in a taxable account, you'll see the compound interest and all and in the case of a disaster and somehow you needed the fund, you will have more money in your account and be better off to handle it. That thinking may be wrong though? Still figuring it out
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

goblue100 wrote:
YoungBoglehead wrote: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!
First, I'd like to say you are ahead of most people your age just by knowing enough that you should have an emergency fund. I've read most of the replies and I would say most of the pro's and cons of keeping cash on hand have been covered. Mine own commetn would be when the sky is falling, and I most certainly thought it was in 2001 and 2008, I'd rather be a buyer than a seller.

Second, per your comment above, I'd like to reccomend a book:
Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich by Jason Zweig

There are many other book on the psychology of money and investing, but I've read this one and got some pretty good insights into myself.
I appreciate that. I do agree with you and tend to think that way also, that if there was some crash I'd love to be a buyer (and an ER fund would be perfect) although that goes against the 'don't time the market' idea
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by YoungBoglehead »

I'm glad I was at least able to make some topic that is worth talking about! Also seems a good number of people agree which means I was not 100% wrong here and there was some logic behind it mathematically.

I see the points made for an ER fund though and agree with a lot of them
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Raybo »

You write:
YoungBoglehead wrote:it adds up just like every dollar. If you chose to invest the ER fund in a taxable account, you'll see the compound interest and all and in the case of a disaster and somehow you needed the fund, you will have more money in your account and be better off to handle it.
How do you know "you will have more money in your account"? You assert this but offer no data to substantiate it. You may be right. You may be wrong. If you're right, you make a little bit of taxable money. If you're wrong, you lose your future.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by downshiftme »

You may be right. You may be wrong. If you're right, you make a little bit of taxable money. If you're wrong, you lose your future.
I think there's a larger range of options here. If all goes well, the investment pays off. If all almost goes well, you might be about the same as a cash emergency fund. If all goes poorly, you could lose more money by investing this way but still be okay in the long run. If all goes quite poorly you could really miss the cash emergency fund. If all goes very poorly indeed, but just the right amount of poorly, you could lose your future in a way that a cash emergency fund would have saved. If all goes poorly beyond that, you lose your future no matter what you did.

Your analysis that you need a cash emergency fund because some range of outcomes might be very costly without one, needs to incorporate the likelihood of such an occurrence and the cost of maintaining the "insurance" of the cash fund. This is not a simple question. We don't insure all risks at any cost. We insure certain kinds of risks at cost-effective rates.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by BanditKing »

This has been a great conversation to read, but I think one of the things that keeps getting danced around is the fact that everyone has different definition of cash.

For some, it's what you have in your wallet. Others it' that liquid pot of money that (should) never lose principle. Others still it's something easily liquefied with minimal risk of principle. For others still its a giant bucket of 100% equities 2x what you might ever need liquid to allow for the crash at the zombie apocalypse. Without that common definition, the question of where to put one's "cash" emergency fund is hard to discuss, let alone agree on an answer for.

For me, in my IPS I split my emergency fund in two ways:
  • 25% High Yield Savings (about 2 months worth) which currently earns 1% with no risk
    75% Short- or Limited-term Tax-exempt Municipal funds (another 6 months) which hopefully does better, but has a little risk
However, in my AA (which I don't count my EF as part of), I also have a category called "Cash", and here I put everything into a Short- or Limited-Term TE Municipals. For my definition of cash, I consider it to be something "minimal risk of principle" coupled with "easily liquefied to my checking account in 7 days". To me, this is a category of "less risk" than even TBM, but more risk/return than a money market fund.

In the end, we all circle back to the base rules. Do your research, write your IPS, determine your AA, and stick to the plan. put your Emergency Fund/Cash at whatever risk threshhold you define. If your comfort for your EF is 0% risk, and you have plenty of choices in the form of HY Savings, MMs, CD, iBonds, etc, then that's perfectly great! If you want it all on bitcoins, well .... make sure your IPS supports it. :)
Last edited by BanditKing on Wed Dec 04, 2013 9:15 pm, edited 1 time in total.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by indian86 »

I keep 100k in savings - 9% of my net worth. I think of it as a combination or emergency fund, or maybe sometime I want to buy a small boat, redo a bathroom, or buy a small cottage by a lake...on somewhat of a whim. I just like having cash on hand - flexibility and security.

The other 1 mill is in real estate and various bond and stock funds.

I guess that is a question I have. Does the energency fund rule continue to apply to financial planning once your assets/net worth reach a certain level? I mean if you have 500k in stock and bond funds that are liquid, does it really matter is you lose your job. Certainly you can find a bond fund or a stock fund that hasn't done much to get some funds for the relative short term.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by TheTimeLord »

indian86 wrote:I keep 100k in savings - 9% of my net worth. I think of it as a combination or emergency fund, or maybe sometime I want to buy a small boat, redo a bathroom, or buy a small cottage by a lake...on somewhat of a whim. I just like having cash on hand - flexibility and security.

The other 1 mill is in real estate and various bond and stock funds.

I guess that is a question I have. Does the energency fund rule continue to apply to financial planning once your assets/net worth reach a certain level? I mean if you have 500k in stock and bond funds that are liquid, does it really matter is you lose your job. Certainly you can find a bond fund or a stock fund that hasn't done much to get some funds for the relative short term.
My answer is yes, maybe an even more important role once your income is derived primarily from investments and that is to allow you to more comfortably navigate the ebb and flow of the market. Now can you accomplish something similar with high grade bonds, certainly but there are differences that may or may not alter yor sleeping patterns.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by berntson »

indian86 wrote: I guess that is a question I have. Does the emergency fund rule continue to apply to financial planning once your assets/net worth reach a certain level? I mean if you have 500k in stock and bond funds that are liquid, does it really matter is you lose your job. Certainly you can find a bond fund or a stock fund that hasn't done much to get some funds for the relative short term.
That seems exactly right to me. An extreme case: Warren Buffet doesn't need an emergency fund. It might be convenient for him to have cash lying around, but it's not necessary. When your finances are in good order, it's whatever floats your boat.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Code Commit »

YoungBoglehead wrote: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!
Are you paraphrasing Mike Tyson?
Everybody has a plan until they get punched in the mouth
I don't have serious opposition to your idea, but is having 3-6 months of expenses in cash vs having it all in equities, going to make a big difference to your retirement after a long time?
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by JamesSFO »

I as someone in Silicon Valley who has been through the dotcom bust and the 08 housing bust and end up out of work (briefly) during both, having more of an emergency fund is a HUGE relief.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by goblue100 »

YoungBoglehead wrote: I appreciate that. I do agree with you and tend to think that way also, that if there was some crash I'd love to be a buyer (and an ER fund would be perfect) although that goes against the 'don't time the market' idea
Timing the market in the absence of knowledge, because we think it may go up or down or some expert on CNBC said it would is one thing. Timing the market after a 50% haircut is another. I probably keep too much cash on hand in general, but having that money available gave me the confidence to put some of that money into action late 2008 and early 2009.
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Emergency Fund ?

Post by Taylor Larimore »

Bogleheads:

This is an earlier post I wrote on the subject:
Emergency Fund definition: "Cash set aside in a dedicated interest account to cover unanticipated emergencies such as property repairs, medical expenses and car repairs."--Financial Glossary

In my opinion, most investors do not need a separate "Emergency Fund" as described above. What we need is a "source" of ready cash--not necessarily another separate, low-yielding account (other than a checking account).

Pat and I have not had a separate "Emergency Fund" for many years. Like most Bogleheads, we know that if it becomes necessary, we can get money from our checking account, portfolio, credit card, bank, home equity loan, life insurance, family, etc.

For young working investors, a Roth IRA can be an excellent emergency fund. Of course, no one likes to take emergency funds from contributions in a retirement account, but if it is necessary (and may never be), its better than delaying the start of a tax-free Roth.

For older investors, with sizable retirement portfolios, emergency funds are normally no problem.

In my opinion, the idea that everyone must have a separate "emergency fund" is an investing myth.
Best wishes.
Taylor
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by NuB 2013 »

Personally if I had to a chance to re-do that step starting 10 years ago, I would have bought a steady stream of I-Bonds via direct deposit from each paycheck via Treasury Direct to solidify the emergency fund foundation.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by TheTimeLord »

NuB 2013 wrote:Personally if I had to a chance to re-do that step starting 10 years ago, I would have bought a steady stream of I-Bonds via direct deposit from each paycheck via Treasury Direct to solidify the emergency fund foundation.
+1
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by SGM »

We have never had an emergency fund as such. Cash is a drag on returns over the long haul. I have always been confident that I could find work regardless of the state of the economy.

If a long term illness or severe accident happened, I don't think 6 months of expenses would be enough. I have never paid for disability insurance, but if your family depends on your good health and employment it may be a worthwhile purchase. SS disability is another backup for some, but wouldn't replace a salary.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by pkcrafter »

YoungBoglehead wrote:
I appreciate that. I do agree with you and tend to think that way also, that if there was some crash I'd love to be a buyer (and an ER fund would be perfect) although that goes against the 'don't time the market' idea
No, it has nothing to do with market timing. When the market is down you need to rebalance into equity.

Here's the type of scenario you need to avoid -- young investors who are very high in equity may have to sell some marked for retirement. If there is little in bonds, there's no money to rebalance, and worse, equity will be sold at a loss. The biggest problem with this is the loss of the future compounding the lost retirement assets would have generated. If tax deferred accounts have to be tapped, the money may not even be replaceable.

Things are a little different in retirement. With no income, there is only the accumulated assets available to cover all costs, whether they are planned or emergency. These is also usually a good supply of cash and bonds to tap, so equity is not sold at a market bottom.

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

Post by rkhusky »

It's not so bad selling at the bottom, as long as you are tax loss harvesting and putting the redemptions back into the market.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by Rodc »

rkhusky wrote:It's not so bad selling at the bottom, as long as you are tax loss harvesting and putting the redemptions back into the market.
Does that mean it is an unfortunate thing if instead you spend the redemptions because, as per the thread, you have an emergency you are dealing with (the reasons for the redemption in the first place)?
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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Re: I'd like to challenge the logic behind a 'disaster fund'

Post by ruralavalon »

HomerJ wrote:When are you more likely to lose your job?

During a recession when stock prices are dropping? Or during a boom time when stock prices are rising?
Or during a very long slump after a deep recession, when stock prices are soaring to all-time highs?
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