If you have a sizable portfolio, you don't need an emergency fund

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millennialmillions
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If you have a sizable portfolio, you don't need an emergency fund

Post by millennialmillions »

There have been many recent topics explaining why everyone needs an emergency fund and why it should never be intermingled with other investments.

I disagree with that, and I did some analysis to show why. Many investors are better off without an emergency fund, instead investing all extra cash according to their typical asset allocation. Assuming a large enough portfolio, this strategy can mitigate the downside risk by selling investments to cover expenses in case of emergency. But the real differentiator is that it also maximizes the upside. By having more money invested, you will end up with a greater net worth over time.

Of course, this strategy is only viable if you have a portfolio that can take a hit and still cover your expenses in an emergency. If you haven’t yet reached that point, saving in a more traditional emergency fund is beneficial. But if you’ve started to accumulate some wealth, you’re better off without an emergency fund.

What is an emergency fund?

The general purpose of an emergency fund or a “rainy day fund” is to ensure you can cover expenses in an unexpected financial emergency, such as job loss or large medical bills. The exact definition of an emergency fund is a bit murky, but there are two generally agreed-upon traits:
  • Held in cash or highly liquid vehicle such as a checking account, saving account, or money market fund
  • Able to cover 6-12 months of expenses
Holding a traditional emergency fund like this is one way to mitigate financial downside, but it is not optimal. To determine what is optimal, we need to assess the ultimate goal of an emergency fund. Breaking it down, the goals are:
  1. Have enough cash in hand to cover immediate expenses
  2. Be able to withstand a period of up to a year with no income
The first goal should be met through the standard operating cash that you have available, without requiring an emergency fund. For example, I keep two months of expenses in my checking account for rent, food, etc. The second goal can then be accomplished with financial vehicles that can take a few days to get cash in hand. This opens many possible solutions, including cash under a mattress, gold buried in your backyard, money in a saving account, or a sizable investment portfolio.

Since all of these could meet the goals of an emergency fund, how can we choose which is optimal? We need another goal.

What an Emergency Fund Should Be – Mitigate Risk and Maximize Net Worth

The two previously mentioned goals of an emergency fund relate to reducing downside risk. But what about the upside? We shouldn’t mitigate risk without thinking about how it can impact our ability to accumulate more wealth. So, let’s add a third goal:
  1. Have enough cash in hand to cover immediate expenses
  2. Be able to withstand a period of up to a year with no income
  3. After the above two goals are met, maximize net worth over time
If your portfolio is large enough to withstand a significant drop and still cover a year’s expenses, these three goals are best met without a traditional emergency fund. The first goal is met by your operating cash, the second by selling investments, and the third by adding as much money to your investment portfolio as possible.

This is intuitive: having more money invested and less in cash will come out ahead over time. But some argue that being forced to sell stocks at a low price after a market downturn will offset the higher average returns from the additional investment. To analyze that counterpoint, let’s look at history.

History Shows that No Emergency Fund Performs Better

We’ll analyze two investors over the period from 2000 through 2019, which includes two major market downturns. Both investors started with annual income of $65,000 and expenses of $40,000 that increased with inflation each year. Both kept sufficient operating expenses in a checking account to meet liquid cash need. One investor (EF) saved an additional year of expenses in an emergency fund, with returns that equal inflation. The other (no-EF) invested in a 100% equity portfolio of the Vanguard Total Stock Market Fund (VTSMX or VTI).

The two investors are compared across two scenarios: the worst-case scenario and the best-case scenario. In the worst-case scenario, both investors lost their jobs and had zero income in both 2002 and 2008. The EF investor covered expenses from his emergency fund, and the no-EF investor sold stocks to cover expenses. In the best-case scenario, both investors maintained their jobs throughout the 20-year period. Here is how they fared:

Image

In both scenarios, the No-EF investor comes out ahead. Surprisingly, the difference between the two investors is more pronounced in the worst-case scenario when they lose their jobs. In this case the No-EF investor ends up with a net worth $100,000 (6%) higher.

While it is true the No-EF investor is forced to sell stocks low, he also buys back in low, shortly after the crash. The EF investor, on the other hand, misses out on this buying opportunity because he spends the next year-and-a-half building back his emergency fund before buying more stock. This causes the EF investor to miss the significant market gains after the crashes.

Unsurprisingly, the No-EF investor also wins in the best-case scenario, though the net worth difference is less pronounced at only 3%.

Portfolio Size Needed to Forgo an Emergency Fund

Based on this analysis, it is clear that an investor with a large enough portfolio should forgo an emergency fund. The question, then, becomes: how large of a portfolio is “large enough”?

The portfolio needs to be able to cover a year’s expenses even after a sharp drop. The largest one-year decline of the S&P 500 was 43.3% in 1931. To be extra conservative, let’s assume that a market drop of 75% is possible. To withstand that drop, your available portfolio would need to be 4 times your annual expenses. For example, a portfolio of $200,000 could fall 75% and still cover $50,000 in expenses if sold. If the market drops more than 75%, you likely have bigger societal problems that wouldn’t be solved by any emergency fund.

This amount must be available for you to withdraw without penalty. This includes regular taxable investments and Roth IRA and 401k contributions (after 5 years), but it does not include traditional 401k contributions.

TLDR

If you have built a sizable portfolio, you don’t need a separate stash of cash as your emergency fund. Instead, you can invest all funds according to your asset allocation and sell in case of emergency. This strategy will effectively mitigate your financial downside while also maximizing your net worth over time. This is true in both a worst-case scenario when you lose your income and a best-case scenario when you retain it.

A better-formatted post with detailed calculations and Excel file is available here
Last edited by millennialmillions on Fri Apr 10, 2020 4:28 pm, edited 2 times in total.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by simplesimon »

The recent surge of posts from people selling and going to cash even when they haven't suffered job loss will tell you that the behavioral aspect of investing is really important. Lots of rational people do irrational things when stocks fall 30% in a couple weeks.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Jack FFR1846 »

"Sizable" is a nebulous term. Can you define this wrt annual spending? My goal is to have 50 times spending in my investment portfolio. Along with this, I have cash of somewhere around 1 year of spending plus almost 8 years spending in US Savings Bonds, which I consider invested in Bond category. I find that at times where we decide to do a large expenditure, like a roof and a car last year, this makes it quite easy to undertake. I would submit that if one is to invest everything, then they'd want to take some percentage of the investment and classify it as emergency fund...in something like savings bonds or a bond fund and NOT count it in their "times spending" number. Especially if one is stuck in the 90's with a 4% spend rate goal. I will admit that I'm a very "safety net" guy with back ups for back ups. So yah....today, investments are at 45.55 times spending with another 1 year in cash.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by millennialmillions »

Jack FFR1846 wrote: Thu Apr 09, 2020 10:35 am "Sizable" is a nebulous term. Can you define this wrt annual spending? My goal is to have 50 times spending in my investment portfolio. Along with this, I have cash of somewhere around 1 year of spending plus almost 8 years spending in US Savings Bonds, which I consider invested in Bond category. I find that at times where we decide to do a large expenditure, like a roof and a car last year, this makes it quite easy to undertake. I would submit that if one is to invest everything, then they'd want to take some percentage of the investment and classify it as emergency fund...in something like savings bonds or a bond fund and NOT count it in their "times spending" number. Especially if one is stuck in the 90's with a 4% spend rate goal. I will admit that I'm a very "safety net" guy with back ups for back ups. So yah....today, investments are at 45.55 times spending with another 1 year in cash.
The portfolio needs to be able to cover a year’s expenses even after a sharp drop. The largest one-year decline of the S&P 500 was 43.3% in 1931. To be extra conservative, let’s assume that a market drop of 75% is possible. To withstand that drop, your available portfolio would need to be 4 times your annual expenses. For example, a portfolio of $200,000 could fall 75% and still cover $50,000 in expenses if sold. If the market drops more than 75%, you likely have bigger societal problems that wouldn’t be solved by any emergency fund.

This amount must be available for you to withdraw without penalty. This includes regular taxable investments and Roth IRA and 401k contributions (after 5 years), but it does not include traditional 401k contributions.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by watchnerd »

millennialmillions wrote: Thu Apr 09, 2020 10:22 am There have been many recent topics explaining why everyone needs an emergency fund and why it should never be intermingled with other investments.

I disagree with that, and I did some analysis to show why. Many investors are better off without an emergency fund, instead investing all extra cash according to their typical asset allocation. Assuming a large enough portfolio, this strategy can mitigate the downside risk by selling investments to cover expenses in case of emergency. But the real differentiator is that it also maximizes the upside. By having more money invested, you will end up with a greater net worth over time.

Of course, this strategy is only viable if you have a portfolio that can take a hit and still cover your expenses in an emergency. If you haven’t yet reached that point, saving in a more traditional emergency fund is beneficial. But if you’ve started to accumulate some wealth, you’re better off without an emergency fund.
Just FYI:

There are a ton of existing threads on the difference between an "emergency strategy" vs an "emergency fund" and that you don't need a segregated EF once your portfolio gets big enough.

We haven't had a separate EF in years due to portfolio size and how many years of living expenses our fixed income allocation represents for us.

The short TIPS portion of our AA (see sig) is held in taxable and covers 5-6 years of living expenses without even touching long Treasuries or stocks. Plus no debt or mortgage.
70% Global Market Weight Equities | 15% Long Treasuries 15% short TIPS & cash || RSU + ESPP
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by millennialmillions »

watchnerd wrote: Thu Apr 09, 2020 10:42 am Just FYI:

There are a ton of existing threads on the difference between an "emergency strategy" vs an "emergency fund" and that you don't need a segregated EF once your portfolio gets big enough.

We haven't had a separate EF in years due to portfolio size and how many years of living expenses our fixed income allocation represents for us.

The short TIPS portion of our AA (see sig) is held in taxable and covers 5-6 years of living expenses without even touching long Treasuries or stocks. Plus no debt or mortgage.
Thank you for pointing that out - I agree we're really talking about an "emergency strategy," and yours seems much safer than most "emergency funds."

In previous threads, when I discussed not keeping an emergency fund and instead investing according to my allocation of 100% equities, I was told that would be a losing strategy because I would be forced to sell low. That was the impetus for this post - I wanted to see if selling low would really offset the additional gains from equities. I found that it does not.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Luckywon »

millennialmillions wrote: Thu Apr 09, 2020 10:22 am
This amount must be available for you to withdraw without penalty.

Just a note that in the recent drop in equities valuation I found it very easy to raise needed cash without capital gains (especially in my international funds in the red all the way back to 2011).

I abandoned having an EF a few years back, it's reassuring to see your elegant analysis above.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by carmonkie »

There are many ways to skin the EM cat, you gave your valid personal opinion, but there are also home dynamics that come into play as well. We have our EM in a joint account. My wife wanted all cash so we compromised and we have 9months in MM, while the other 3 months are on Total World ETF. This is about 80/20 in terms of AA. So after this COVID thing we were down for a while down to 10.5 months.
I hope with time we can get to 70/30 or even 60/40 but for now we are happy where it is. We sleep good at night with all this uncertainty and keeps the Mrs. happy in the process.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by rbaldini »

This has been my strategy for a while. Seemed like obvious logic to me: Even if the market tanks 90%, I can still pay my bills and feed myself for a long time. So I have no need for a separate cash bucket, which means I can invest that money in more useful assets.

The same logic can be used to argue that those with more net worth should have a higher stock allocation, because they can afford to lose more without going broke. People get flustered about this idea because it implies you might have to sell stock after a downturn if you ever do need to access cash (eg you lose your job) which they consider unthinkable for various fallacious reasons (“locking in your losses” and all that).
Last edited by rbaldini on Thu Apr 09, 2020 11:38 am, edited 1 time in total.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by watchnerd »

Luckywon wrote: Thu Apr 09, 2020 11:00 am
millennialmillions wrote: Thu Apr 09, 2020 10:22 am
This amount must be available for you to withdraw without penalty.

Just a note that in the recent drop in equities valuation I found it very easy to raise needed cash without capital gains (especially in my international funds in the red all the way back to 2011).

I abandoned having an EF a few years back, it's reassuring to see your elegant analysis above.
Tax optionality is where having something other than stocks can be beneficial if one is still sitting on long gains after a market drop.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Luckywon »

watchnerd wrote: Thu Apr 09, 2020 11:35 am
Luckywon wrote: Thu Apr 09, 2020 11:00 am
millennialmillions wrote: Thu Apr 09, 2020 10:22 am
This amount must be available for you to withdraw without penalty.

Just a note that in the recent drop in equities valuation I found it very easy to raise needed cash without capital gains (especially in my international funds in the red all the way back to 2011).

I abandoned having an EF a few years back, it's reassuring to see your elegant analysis above.
Tax optionality is where having something other than stocks can be beneficial if one is still sitting on long gains after a market drop.
watchnerd could you expand a bit on what you are referring to here?
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Watty »

If you have a sizable portfolio, you don't need an emergency fund
I didn't follow your entire post but as you become more financially secure then your definition of "emergency" will likely change a lot.

When I was in my 20's something like a car repair or dental bill would have been a bit of an "emergency". (Been there done that, could not afford the tee shirt. :D )

Once I was was better established things like that were just routine unplanned expenses and even things like needing a new roof or furnace that might cost 10s of thousands of dollars are eventually not emergencies since you know that you will eventually have expenses like that, just not when you will have them.

Things like major medical expenses would be covered by insurance which usually has an out of pocket maximum that would not be an emergency to cover for someone that is financially secure.

Eventually about the only sort of true emergency would be things like if you lost your job and did not have enough to retire on.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Sandtrap »

Interesting analysis and points.
The "Elephant In The Room" is "sleep factor" which is unique to every person.

. . . and, it may have nothing to do with portfolio size not needing an EF.

For some, it's. . . .
Cash. . . lot's of cash. . .
A large fixed allocation. . .
A substantial Emergency Fund (whether underlying consists of cash, CD's, MM, etc, etc)
Zero debt and a paid off home. . .
An enormous portfolio from 25X to 50X to 100X
Overall substantial wealth, mega wealth. ..
A hefty pension and SS and annuities that more than cover expenses, outside of a small to medium portfolio
And so forth. . .

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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by millennialmillions »

carmonkie wrote: Thu Apr 09, 2020 11:23 am There are many ways to skin the EM cat, you gave your valid personal opinion, but there are also home dynamics that come into play as well. We have our EM in a joint account. My wife wanted all cash so we compromised and we have 9months in MM, while the other 3 months are on Total World ETF. This is about 80/20 in terms of AA. So after this COVID thing we were down for a while down to 10.5 months.
I hope with time we can get to 70/30 or even 60/40 but for now we are happy where it is. We sleep good at night with all this uncertainty and keeps the Mrs. happy in the process.
That's a valid point and something I struggled with initially. It is counter-intuitive that maintaining an emergency fund actually hurts your finances during a market downturn. It took a few weeks of conversation to convince DW that putting it all in equities was safe and prudent.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by millennialmillions »

rbaldini wrote: Thu Apr 09, 2020 11:25 am The same logic can be used to argue that those with more net worth should have a higher stock allocation, because they can afford to lose more without going broke. People get flustered about this idea because it implies you might have to sell stock after a downturn if you ever do need to access cash (eg you lose your job) which they consider unthinkable for various fallacious reasons (“locking in your losses” and all that).
This is a great point. The "locking in losses" argument is what prompted me to do this analysis - it seems people repeat that without checking how an EF-free strategy would have done historically. I was surprised by how large of a drag an EF can have on your net worth by preventing you from buying after a market crash.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by JakeyLee »

This is a great topic, and one near and dear to me. Some years ago I quit referring to my cash allocation as my emergency fund. Semantics aside, all money is fungible. I could argue (with myself) that the first 3-6 months of my cash allocation is the emergency portion. I'm just not sure it matters. I typically keep around 1.5 years of expenses fairly liquid in my money market fund. I send cash there monthly. I have accepted that this fund is just another part of my allocation. I even re-balance in after tax accounts when the market falls below my bands. All my investments are 100% equities. Except my cash fund.. Which really means I'm not 100% equities. :oops: Now if you'll excuse me, I have some windmills I need to battle. :beer
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Broken Man 1999 »

There is no place for logic for certain things. Same for mathematical solutions.

Personal finance is just that, personal.

As such, perhaps the best answer is people should hold an emergency fund if they are
more comfortable doing so, and an EF allows them to SWAN.

Some folks, myself included, do not hold EF, or carve out parts of our portfolio to be used for this and that.

Every investor should do what works best for them, there is no right or wrong answer, just an answer that works for the individual.

Everything else (including my post) is just just noise.

Any mathematical presentation on the subject means little to a person who cannot SWAN without an EF, no matter the reason.

Saying someone needs or doesn't need an EF might mean something to the person who gives such an opinion, but no one can determine the various needs across the investing body.

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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Triple digit golfer »

I think the sleep at night factor is important. I know that if I lost my job today, I would want at least a few months of expenses in cash. I don't know if that's rational or what, but it is important to me. I don't want to have to sell stocks to pay a mortgage payment due tomorrow. Obviously, I know that the author said two months in cash. That's good advice for anybody and a good starting point.

Where I'm intrigued is when unemployment hits and the portfolio must act as the emergency fund, which option is optimal and why?

A. Sell at portfolio AA regardless of whether stocks are at a loss or not; portfolio then always remains at desired AA. When you find employment, simply continue where you left off contributing per AA.

B. Sell bonds first, then when you find employment, new contributions go to bonds until replenished and back to desired AA.

C. Sell bonds first, then when you find employment, immediately exchange equities in portfolio to bonds to maintain AA, and new contributions go in at AA.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Broken Man 1999 »

There is no place for logic for certain things. Same for mathematical solutions.

Personal finance is just that, personal.

As such, perhaps the best answer is people should hold an emergency fund if they are
more comfortable doing so, and an EF allows them to SWAN.

Some folks, myself included, do not hold EF, or carve out parts of our portfolio to be used for this and that.

Every investor should do what works best for them, there is no right or wrong answer, just an answer that works for the individual.

Everything else (including my post) is just just noise.

Any mathematical presentation on the subject means little to a person who cannot SWAN without an EF, no matter the reason.

Saying someone needs or doesn't need an EF might mean something to the person who gives such an opinion, but no one can determine the various needs across the investing body.

Way too much advice is given that doesn't account for the individual who is making decisions. We are not machines whose needs can be satisfied with a formula, a calculation. And perhaps even more important, humans do not always make rational decisions. We are imperfect. We are individuals, not part of an investing collective.

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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by BW1985 »

I agree with this I just don't think at this point in time it really matters. With bond yields so low you're not missing out on much by having your fixed income in cash instead, which is what people usually keep their EF in. If we were back in 1999 that'd be different.
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Re: If you have a sizable portfolio, you don't need an emergency fund

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This topic has been moved from the Personal Investments forum to Investing - Theory, News & General forum.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by nisiprius »

Emergency funds are a "just eat your broccoli" thing.

You do need an emergency plan.

I agree that if you have a sizable portfolio, you don't need a dedicated cash emergency fund.

But if you have a sizable portfolio, the drag from having one doesn't matter enough to fuss about.

The Achilles heel of any attempt to simulate or optimize anything about emergency funds is the lack of any good, widely-known statistical data on the size and frequency of "emergencies..." as well as anything other then anecdotes and experience on what forms of payment are accepted, in real life, under what situations, when.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Psychopasta »

nisiprius wrote: Thu Apr 09, 2020 2:55 pm The Achilles heel of any attempt to simulate or optimize anything about emergency funds is the lack of any good, widely-known statistical data on the size and frequency of "emergencies..."
I agree. As my net worth portfolio has increased, my EF allocation has gone down and is less than 50% of what it was earlier in my life, when it really could have kept us afloat for two months or so. The bigger your portfolio, the less you'll need an EF, but the size of EF you'll want will be set by your tolerance for risk etc. Simply maximizing return on investment value is one strategy and it's fine, but I, and I suspect many other Bogleheads, am happy to sub-optimize ROI for Sleep Quality Factor etc. You never know what will constitute an emergency in your life, and it doesn't have to be a macro-economic hit. In fact, it's likely nothing to do with the economy. Think about repatriating a kid via air ambulance...
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by millennialmillions »

nisiprius wrote: Thu Apr 09, 2020 2:55 pm But if you have a sizable portfolio, the drag from having one doesn't matter enough to fuss about.

The Achilles heel of any attempt to simulate or optimize anything about emergency funds is the lack of any good, widely-known statistical data on the size and frequency of "emergencies..." as well as anything other then anecdotes and experience on what forms of payment are accepted, in real life, under what situations, when.
I previously agreed with your point that the drag wasn't enough to fuss about. However, the above analysis showed a 20% difference in net worth for investors who went through emergencies in the dot-com boom and the subprime mortgage crisis. That's a big difference for a decision most people leave to their gut.

The lack of data on "emergencies" is certainly an issue when attempting to do this analysis, which is why I stuck with two scenarios. While there isn't a one-size-fits-all approach for emergency planning, it seems many people would come out ahead financially without a traditional emergency fund.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by H-Town »

Good post. I agree with the thesis. I don't have a EF since my portfolio is large enough (700k+). It's all mental accounting if one accounts for buckets when their portfolio is large enough. Admittedly, when I started out professionally, it took me a long time to build up a 12 month expense EF in cash. It took discipline to accumulate that much cash without putting it in the stock market.

The argument against this thesis is that not everyone can see logic when market takes a dive. You can show them all the numbers, calculation, projection, historical data, etc. Nothing works. They will sell stocks and hold on to cash. They don't care about their wealth in 20-40 years from now. Their immediate need is right now.

So the advice would need to take into account each person's taste for risk (or fear of losing).
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by 123 »

If there is an extended "Trading Halt" having a sizable portfolio won't help if you can't liquidate. Oh, you say an extended "Trading Halt" isn't a likely occurrence? Neither was our current situation two months ago.

An emergency fund provides cash when other regular expected sources of cash are not available.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by millennialmillions »

123 wrote: Thu Apr 09, 2020 3:42 pm If there is an extended "Trading Halt" having a sizable portfolio won't help if you can't liquidate. Oh, you say an extended "Trading Halt" isn't a likely occurrence? Neither was our current situation two months ago.

An emergency fund provides cash when other regular expected sources of cash are not available.
Do you advocate keeping an emergency fund in physical cash? If there is an extended trading halt, that may coincide with a bank run, so you wouldn't be able to withdraw from a checking or saving account either. And if you have physical cash, your house might be ransacked during this time of turmoil.

Those scenarios are both extremely unlikely and difficult to prevent, so I don't tune my strategy to them.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by watchnerd »

Luckywon wrote: Thu Apr 09, 2020 11:39 am

watchnerd could you expand a bit on what you are referring to here?
Selling at a loss isn't the only problem to address.

Selling at an unwanted gain, and paying taxes on the gain, is another.

You can still be sitting on gains if the market goes down. Selling stocks to pay bills forces you to realize those gains.

Drawing down other assets can either be tax-free (cash) or lower cap gains (bonds), thus losing less to taxes.

Having other assets to choose from gives you optionality for the tax consequences.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by manuvns »

my emergency funds is HELOC + credit card access checks and us treasury i series bond if i am out of these .
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by CascadiaSoonish »

I can't argue with the math. But behavioral and emotional factors are something else entirely. Personally, I'm fully aware of the opportunity and deflationary costs of reserving a cash EF. But with fluctuating income, a single-income household, and "enough" already invested, I'm fine with keeping a EF-like cash position even when the math says that's not the optimal choice. So like others here I think it's fair to point out the psychological benefit of maintaining an EF if it helps the investor sleep at night. But that's a personal choice.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by sharukh »

watchnerd wrote: Thu Apr 09, 2020 10:42 am
millennialmillions wrote: Thu Apr 09, 2020 10:22 am There have been many recent topics explaining why everyone needs an emergency fund and why it should never be intermingled with other investments.

I disagree with that, and I did some analysis to show why. Many investors are better off without an emergency fund, instead investing all extra cash according to their typical asset allocation. Assuming a large enough portfolio, this strategy can mitigate the downside risk by selling investments to cover expenses in case of emergency. But the real differentiator is that it also maximizes the upside. By having more money invested, you will end up with a greater net worth over time.

Of course, this strategy is only viable if you have a portfolio that can take a hit and still cover your expenses in an emergency. If you haven’t yet reached that point, saving in a more traditional emergency fund is beneficial. But if you’ve started to accumulate some wealth, you’re better off without an emergency fund.
Just FYI:

There are a ton of existing threads on the difference between an "emergency strategy" vs an "emergency fund" and that you don't need a segregated EF once your portfolio gets big enough.

We haven't had a separate EF in years due to portfolio size and how many years of living expenses our fixed income allocation represents for us.

The short TIPS portion of our AA (see sig) is held in taxable and covers 5-6 years of living expenses without even touching long Treasuries or stocks. Plus no debt or mortgage.
TIPS in taxable account. Won’t that make filing taxes difficult?

Are you using a mutual fund or straight TIPS that mature?

Thank you
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by watchnerd »

sharukh wrote: Thu Apr 09, 2020 4:25 pm
watchnerd wrote: Thu Apr 09, 2020 10:42 am
millennialmillions wrote: Thu Apr 09, 2020 10:22 am There have been many recent topics explaining why everyone needs an emergency fund and why it should never be intermingled with other investments.

I disagree with that, and I did some analysis to show why. Many investors are better off without an emergency fund, instead investing all extra cash according to their typical asset allocation. Assuming a large enough portfolio, this strategy can mitigate the downside risk by selling investments to cover expenses in case of emergency. But the real differentiator is that it also maximizes the upside. By having more money invested, you will end up with a greater net worth over time.

Of course, this strategy is only viable if you have a portfolio that can take a hit and still cover your expenses in an emergency. If you haven’t yet reached that point, saving in a more traditional emergency fund is beneficial. But if you’ve started to accumulate some wealth, you’re better off without an emergency fund.
Just FYI:

There are a ton of existing threads on the difference between an "emergency strategy" vs an "emergency fund" and that you don't need a segregated EF once your portfolio gets big enough.

We haven't had a separate EF in years due to portfolio size and how many years of living expenses our fixed income allocation represents for us.

The short TIPS portion of our AA (see sig) is held in taxable and covers 5-6 years of living expenses without even touching long Treasuries or stocks. Plus no debt or mortgage.
TIPS in taxable account. Won’t that make filing taxes difficult?

Are you using a mutual fund or straight TIPS that mature?

Thank you
I have both some individual TIPS and VTIP (short TIP) fund.

Yes, the individual TIPS can be a tax paperwork problem, but that's what I pay my tax guy to deal with. ;)

That being said, I haven't bought any new ones recently and probably won't buy new ones at the 4/16 auction unless they're a screamingly good deal because I prefer the liquidity convenience of the fund.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by JAZZISCOOL »

Sandtrap wrote: Thu Apr 09, 2020 11:55 am Interesting analysis and points.
The "Elephant In The Room" is "sleep factor" which is unique to every person.

. . . and, it may have nothing to do with portfolio size not needing an EF.

For some, it's. . . .
Cash. . . lot's of cash. . .
A large fixed allocation. . .
A substantial Emergency Fund (whether underlying consists of cash, CD's, MM, etc, etc)
Zero debt and a paid off home. . .
An enormous portfolio from 25X to 50X to 100X
Overall substantial wealth, mega wealth. ..
A hefty pension and SS and annuities that more than cover expenses, outside of a small to medium portfolio
And so forth. . .

j :happy
+1

Everyone has a different view of risk and what helps them sleep at night.

Karsten over at Early Retirement Now is in the camp of believing no EF is necessary.

https://earlyretirementnow.com/?s=EMERG ... order=DESC

However, as other BH's have posted, that's something many people are not comfortable with as evidenced by those who panicked and sold stocks in the last month or so. :shock:

IMO you really need to do an introspective analysis of your risk tolerance before a period of extreme volatility and not during a financial crisis. This means one may want to review their IPS and asset allocation.

https://www.bogleheads.org/wiki/Investm ... _of_an_IPS
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by bertilak »

I didn't read the whole thing but I agree with the sentiment: The more you have the less you need to fine tune and juggle. One size does NOT fit all.

There seems little need to prove that!
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Nate79 »

Our emergency fund includes short duration safe bond funds in taxable that are included in our target asset allocation.

OP, have you been doing this strategy since 2000? I'm curious how many decades you have been following this strategy.

Also inter-year drops are much worse than your example showed.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by petulant »

There are three key flaws with this analysis. Before getting into that, though, I'm curious where you find "many recent topics explaining why everyone needs an emergency fund." I have participated in many recent topics, and it has generally been one reasonable point of view that investors don't need a separate emergency fund.

First, the analysis follows on the conceit that an investor would have a static asset allocation in the investment portfolio, regardless of whether the investor has an emergency fund. This is incorrect in the vast majority of scenarios, or at least it should be if an investor is rational. The investor should select an asset allocation based on the investor's willingness, need, and ability to take risk. Without a separate emergency fund, the investor has a reduced ability to take risk and would generally select a more conservative asset allocation. Thus, what your analysis indicates is not that investors should skip emergency funds. It's that in a specific fact pattern, an investor would have historically made money by using a 100/0 allocation with no emergency fund. Almost no investor would do this for behavioral reasons and because there's no guarantee of the length and severity of a downturn.

Second, it is unclear why you selected 2003 for job loss as part of your analysis. 2003 was a breakout year for the stock market with a 31.35% return. A job loss should have been in 2001, say, to simulate an actual bad outcome. Part of your analysis is thus an investor buying stocks at very low amounts and then selling them in 2003 after good returns. Try running your analysis again with a job loss at the end of 2000.

Third, the analysis relies on a historical period containing two crashes with relatively quick stock rebounds. Try running the analysis again during the 1968-1980 period and let me know how it goes.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by siriusblack »

My wife would divorce me if I invested our emergency fund.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by flyingaway »

If you are not 100% in stocks, you have an emergency fund one way or another.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Silverado »

petulant wrote: Thu Apr 09, 2020 5:53 pm
Thus, what your analysis indicates is not that investors should skip emergency funds. It's that in a specific fact pattern, an investor would have historically made money by using a 100/0 allocation with no emergency fund.
+1well said. Good math From OP, but only useful for very specific assumptions.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by millennialmillions »

petulant wrote: Thu Apr 09, 2020 5:53 pm There are three key flaws with this analysis. Before getting into that, though, I'm curious where you find "many recent topics explaining why everyone needs an emergency fund." I have participated in many recent topics, and it has generally been one reasonable point of view that investors don't need a separate emergency fund.

First, the analysis follows on the conceit that an investor would have a static asset allocation in the investment portfolio, regardless of whether the investor has an emergency fund. This is incorrect in the vast majority of scenarios, or at least it should be if an investor is rational. The investor should select an asset allocation based on the investor's willingness, need, and ability to take risk. Without a separate emergency fund, the investor has a reduced ability to take risk and would generally select a more conservative asset allocation. Thus, what your analysis indicates is not that investors should skip emergency funds. It's that in a specific fact pattern, an investor would have historically made money by using a 100/0 allocation with no emergency fund. Almost no investor would do this for behavioral reasons and because there's no guarantee of the length and severity of a downturn.

Second, it is unclear why you selected 2003 for job loss as part of your analysis. 2003 was a breakout year for the stock market with a 31.35% return. A job loss should have been in 2001, say, to simulate an actual bad outcome. Part of your analysis is thus an investor buying stocks at very low amounts and then selling them in 2003 after good returns. Try running your analysis again with a job loss at the end of 2000.

Third, the analysis relies on a historical period containing two crashes with relatively quick stock rebounds. Try running the analysis again during the 1968-1980 period and let me know how it goes.
Thanks for the response. Here are a few examples:
  • A recent thread, where I brought up the idea of not needing an emergency fund with a large portfolio, and the group consensus was that being forced to sell low would negate all gains.
  • Here, someone with an $800,000 portfolio is advised to hold an emergency fund in a money market account.
  • Another thread where the OP is recommended to build up a emergency fund rather than invest
Addressing your other points,
  1. Many on this forum do not consider an EF as part of their asset allocation. See this thread
  2. In my analysis, I assumed job loss at the end of 2002, leaving the investor unemployed throughout 2003. This is consistent with the highest periods of unemployment from the dot-com crash. See unemployment data here
  3. That period was selected because it included two periods in which many people had financial emergencies. I will run again for your suggested period.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by carminered2019 »

flyingaway wrote: Thu Apr 09, 2020 5:59 pm If you are not 100% in stocks, you have an emergency fund one way or another.
My EF covers 2 years for expenses and everything else goes to 100% equities so I am 96/4(CD) with a total portfolio of 52x yearly expenses with a WR of 1.5%. Crazy not to have EF if you are 100% equities.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by whodidntante »

millennialmillions wrote: Thu Apr 09, 2020 12:36 pm
rbaldini wrote: Thu Apr 09, 2020 11:25 am The same logic can be used to argue that those with more net worth should have a higher stock allocation, because they can afford to lose more without going broke. People get flustered about this idea because it implies you might have to sell stock after a downturn if you ever do need to access cash (eg you lose your job) which they consider unthinkable for various fallacious reasons (“locking in your losses” and all that).
This is a great point. The "locking in losses" argument is what prompted me to do this analysis - it seems people repeat that without checking how an EF-free strategy would have done historically. I was surprised by how large of a drag an EF can have on your net worth by preventing you from buying after a market crash.
I like to say that I'm playing with the house's money. Selling something at a loss wouldn't be the end of the world after all the gains I've received.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Trader Joe »

millennialmillions wrote: Thu Apr 09, 2020 10:22 am There have been many recent topics explaining why everyone needs an emergency fund and why it should never be intermingled with other investments.

I disagree with that, and I did some analysis to show why. Many investors are better off without an emergency fund, instead investing all extra cash according to their typical asset allocation. Assuming a large enough portfolio, this strategy can mitigate the downside risk by selling investments to cover expenses in case of emergency. But the real differentiator is that it also maximizes the upside. By having more money invested, you will end up with a greater net worth over time.

Of course, this strategy is only viable if you have a portfolio that can take a hit and still cover your expenses in an emergency. If you haven’t yet reached that point, saving in a more traditional emergency fund is beneficial. But if you’ve started to accumulate some wealth, you’re better off without an emergency fund.

What is an emergency fund?

The general purpose of an emergency fund or a “rainy day fund” is to ensure you can cover expenses in an unexpected financial emergency, such as job loss or large medical bills. The exact definition of an emergency fund is a bit murky, but there are two generally agreed-upon traits:
  • Held in cash or highly liquid vehicle such as a checking account, saving account, or money market fund
  • Able to cover 6-12 months of expenses
Holding a traditional emergency fund like this is one way to mitigate financial downside, but it is not optimal. To determine what is optimal, we need to assess the ultimate goal of an emergency fund. Breaking it down, the goals are:
  1. Have enough cash in hand to cover immediate expenses
  2. Be able to withstand a period of up to a year with no income
The first goal should be met through the standard operating cash that you have available, without requiring an emergency fund. For example, I keep two months of expenses in my checking account for rent, food, etc. The second goal can then be accomplished with financial vehicles that can take a few days to get cash in hand. This opens many possible solutions, including cash under a mattress, gold buried in your backyard, money in a saving account, or a sizable investment portfolio.

Since all of these could meet the goals of an emergency fund, how can we choose which is optimal? We need another goal.

What an Emergency Fund Should Be – Mitigate Risk and Maximize Net Worth

The two previously mentioned goals of an emergency fund relate to reducing downside risk. But what about the upside? We shouldn’t mitigate risk without thinking about how it can impact our ability to accumulate more wealth. So, let’s add a third goal:
  1. Have enough cash in hand to cover immediate expenses
  2. Be able to withstand a period of up to a year with no income
  3. After the above two goals are met, maximize net worth over time
If your portfolio is large enough to withstand a significant drop and still cover a year’s expenses, these three goals are best met without a traditional emergency fund. The first goal is met by your operating cash, the second by selling investments, and the third by adding as much money to your investment portfolio as possible.

This is intuitive: having more money invested and less in cash will come out ahead over time. But some argue that being forced to sell stocks at a low price after a market downturn will offset the higher average returns from the additional investment. To analyze that counterpoint, let’s look at history.

History Shows that No Emergency Fund Performs Better

We’ll analyze two investors over the period from 2000 through 2019, which includes two major market downturns. Both investors started with annual income of $65,000 and expenses of $40,000 that increased with inflation each year. Both kept sufficient operating expenses in a checking account to meet liquid cash need. One investor (EF) saved an additional year of expenses in an emergency fund, with returns that equal inflation. The other (no-EF) invested in a 100% equity portfolio of the Vanguard Total Stock Market Fund (VTSMX or VTI).

The two investors are compared across two scenarios: the worst-case scenario and the best-case scenario. In the worst-case scenario, both investors lost their jobs and had zero income in both 2003 and 2009. The EF investor covered expenses from his emergency fund, and the no-EF investor sold stocks to cover expenses. In the best-case scenario, both investors maintained their jobs throughout the 20-year period. Here is how they fared:

Image

Image

In both scenarios, the No-EF investor comes out ahead. Surprisingly, the difference between the two investors is more pronounced in the worst-case scenario when they lose their jobs. In this case the No-EF investor ends up with a net worth 20% ($285,000) higher.

While it is true the No-EF investor is forced to sell stocks low, he also buys back in low, shortly after the crash. The EF investor, on the other hand, misses out on this buying opportunity because he spends the next year-and-a-half building back his emergency fund before buying more stock. This causes the EF investor to miss the significant market gains after the crashes.

Unsurprisingly, the No-EF investor also wins in the best-case scenario, though the net worth difference is less pronounced at only 3%.

Portfolio Size Needed to Forgo an Emergency Fund

Based on this analysis, it is clear that an investor with a large enough portfolio should forgo an emergency fund. The question, then, becomes: how large of a portfolio is “large enough”?

The portfolio needs to be able to cover a year’s expenses even after a sharp drop. The largest one-year decline of the S&P 500 was 43.3% in 1931. To be extra conservative, let’s assume that a market drop of 75% is possible. To withstand that drop, your available portfolio would need to be 4 times your annual expenses. For example, a portfolio of $200,000 could fall 75% and still cover $50,000 in expenses if sold. If the market drops more than 75%, you likely have bigger societal problems that wouldn’t be solved by any emergency fund.

This amount must be available for you to withdraw without penalty. This includes regular taxable investments and Roth IRA and 401k contributions (after 5 years), but it does not include traditional 401k contributions.

TLDR

If you have built a sizable portfolio, you don’t need a separate stash of cash as your emergency fund. Instead, you can invest all funds according to your asset allocation and sell in case of emergency. This strategy will effectively mitigate your financial downside while also maximizing your net worth over time. This is true in both a worst-case scenario when you lose your income and a best-case scenario when you retain it.

A better-formatted post with detailed calculations and Excel file is available here
I strongly disagree with your advice.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by millennialmillions »

petulant wrote: Thu Apr 09, 2020 5:53 pm Third, the analysis relies on a historical period containing two crashes with relatively quick stock rebounds. Try running the analysis again during the 1968-1980 period and let me know how it goes.
Edit: changed the starting portfolio to $120,000 rather than $200,000 - results below updated to reflect that.

I ran the analysis for 1965-1985 (to stay consistent testing over a 20-year period). I assumed job loss and no income in 1975 and 1983, which were the highest periods of unemployment during that span.

The investor with no EF came out ahead again, this time by an even bigger margin. The no-EF investor had a net worth 27% higher than the investor with the EF.

Image

Updated Excel file, including the new time period, can be found here
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by MathIsMyWayr »

It all depends on the definition of emergency and emergency fund. In your case, everything outside the emergency is invested in equities. If an emergency is of a short duration such as 6-12 months and infrequent. Having emergency fund or not should not make much of a difference. In this sense, keeping fund idle will lower your asset size in the long run. However, if you also have to consider down markets. Fixed income may be a part of emergency fund. It is well known that investing everything beside a small emergency fund in equities is not optimal as shown by the study of retirees for the last 20 years.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by davebeers »

There are also other factors to consider.
How safe is your job? What is your access to credit?

With a stable job in a “necessary” industry and good access to credit cards with 0% interest...I would argue that an EF could almost be eliminated altogether.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Triple digit golfer »

Triple digit golfer wrote: Thu Apr 09, 2020 1:10 pmWhere I'm intrigued is when unemployment hits and the portfolio must act as the emergency fund, which option is optimal and why?

A. Sell at portfolio AA regardless of whether stocks are at a loss or not; portfolio then always remains at desired AA. When you find employment, simply continue where you left off contributing per AA.

B. Sell bonds first, then when you find employment, new contributions go to bonds until replenished and back to desired AA.

C. Sell bonds first, then when you find employment, immediately exchange equities in portfolio to bonds to maintain AA, and new contributions go in at AA.
Anybody have any thoughts on this?
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by Normchad »

Then again, once you have 25x expenses in your portfolio, you just don’t sweat the theoretical suboptimality of keeping a years expenses in your checking account.

Then I come home and my wife tells me that she heard the stock market was crashing, and I just remind her that we have 100 large in the checking account, and everybody feels better....
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by watchnerd »

Normchad wrote: Thu Apr 09, 2020 9:37 pm Then again, once you have 25x expenses in your portfolio, you just don’t sweat the theoretical suboptimality of keeping a years expenses in your checking account.

Then I come home and my wife tells me that she heard the stock market was crashing, and I just remind her that we have 100 large in the checking account, and everybody feels better....
+1

There comes a point where cash drag doesn't matter much and a few years living expenses is a small fraction of the port.

And if it keeps domestic peace, it's worth a lot.
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Re: If you have a sizable portfolio, you don't need an emergency fund

Post by SnowBog »

watchnerd wrote: Thu Apr 09, 2020 9:39 pm There comes a point where cash drag doesn't matter much and a few years living expenses is a small fraction of the port.

And if it keeps domestic peace, it's worth a lot.
For me personally - 1 year expenses (with zero debt/mortgage) is a small % of my net worth. The domestic peace - and "sleep at night" is worth it to hold it in "savings", even if that means my "growth" is slightly less.

But I could understand for someone where 3-12 months EF is a much higher % of their net worth, there is more willingness to take the risk. (Not my place to judge their ability to take the risk...)
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