Smarter approach to "emergency funds"?

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vineviz
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Smarter approach to "emergency funds"?

Post by vineviz » Wed Mar 25, 2020 10:19 am

Few personal finance topics are as confounding as the "emergency fund".

The concept itself if relatively simple: a household should have enough financial capital withstand unexpected shocks (either a period of unemployment/underemployment or a major unplanned expenses) without undue stress.

But boy, are there lots of details there in which the devil can hide. How much financial capital is "enough"? How should that capital be invested? How big are the "shocks"? When will they hit? How long will they last? How much stress is "undue"? And so on.

The reality is that, like most topics in personal finance, the answers to these questions are highly personal. Someone with highly stable employment (e.g. government employee or some union members) probably needs a smaller reserve than someone with highly irregular employment or income (e.g. your pay is commission-based or you're a contract worker). A household with income near the national median likely has less ability to dial down expenses than a household with income in the top 10%.

Unfortunately, there isn't much high quality research around the frequency, magnitude, or nature of household financial shocks. So the typical advice typically is something like "put away at least three to six months’ worth of expenses". For the purposes of this post, I'm going to assume that you have some way of determining how much money you want to count on in an "emergency". And for purposes of illustration, I'm going to use six months of expense as the benchmark: dial up or down as you see fit.

The thing I want to explore here is HOW/WHERE the emergency fund should be saved/invested.

Most people seem to assume that the emergency fund should be placed in a VERY conservative savings vehicle, like a high-yield savings account or money market account. I don't necessarily agree.

The thing about an emergency fund is that it's dedicated use is to cover unexpected financial shocks. These events are, by definition, unpredictable and unusual. You might be laid off next month, or you could go five or six years without a true financial "emergency". Unfortunately, time is the true enemy of cash. Or, rather, inflation is the true enemy of cash.

$10,000 placed in Treasury bills at the end of 2008 has LOST 15% of its purchasing power since then. Put another way, if $10,000 was six months worth of expenses in 2009, your emergency fund is down to just five months now.

I've said previously that the emergency fund does NOT need to be entirely in cash instruments, just that the household have enough liquidity to persevere scenarios with a reasonable probability of occurring. There are various ways to accomplish this, and one that I think most people should consider as a smarter option is this:

Slightly overfund the emergency fund and invest it in a very conservative balanced fund (e.g. a fund that is 20% to 30% stocks) such as the Vanguard LifeStrategy Income Fund (VASIX).

Since the Great Depression, by my calculation the biggest drawdown an 20/80 combination of stocks and bond has been about 15%. A household that wanted at least six months of financial capital available at all times would simply create an emergency fund with seven months worth of expense and invest it in the Vanguard LifeStrategy Income Fund or similar.

Even if you were INSANELY unlucky and invested at a market peak, an immediate 15% drop would still leave you with more than six months worth of expenses if you were again INSANELY unlucky enough to need the money right at the market bottom.

Liquidity is always a potential concern, so pragmatically most households might be better served with a hybrid approach: one months worth of expenses in a cash account of some sort (e.g. interest-bearing checking, savings, money market fund) that can be accessed immediately, and six months worth of expenses in VASIX.

Here's an illustration of what this "LifeStrategy + Cash" would have looked like in inflation-adjusted (i.e. 1994) dollars versus the traditional advice of keeping the whole emergency fund in cash.

Image

The compounded difference between 3.6% real growth (with VASIX + cash) versus 0.2% (with cash only) is stark, and would have noticeably improved the financial security of household employing this strategy. Some would call VASIX "risky" but for most households, failing to keep up with inflation is a bigger risk than the minimal amount of month-to-month volatility that VASIX introduces.

There's nothing magical about VASIX, necessarily, except that it's fees are low and it is widely available. Fidelity Freedom Index Income (FIKFX), Schwab Monthly Income Max Payout (SWLRX), or Dimensional Retirement Income (TDIFX) might also be good options depending on what's available for you.
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Re: Smarter approach to "emergency funds"?

Post by watchnerd » Wed Mar 25, 2020 10:49 am

Why not short TIPS instead of cash / T-bills?
Last edited by watchnerd on Wed Mar 25, 2020 10:50 am, edited 1 time in total.
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Re: Smarter approach to "emergency funds"?

Post by ScubaHogg » Wed Mar 25, 2020 10:50 am

Nice post with compelling reasoning. I would have said “no way” to the idea of putting an emergency fund into a balanced fund, but you make a good point that slightly overfunding it has historically ensured you had the money when you needed it.

I’m assuming you picked 1994 because that’s when that particular LifeStrategy fund came into being?
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Re: Smarter approach to "emergency funds"?

Post by watchnerd » Wed Mar 25, 2020 10:52 am

ScubaHogg wrote:
Wed Mar 25, 2020 10:50 am
Nice post with compelling reasoning. I would have said “no way” to the idea of putting an emergency fund into a balanced fund
Ditto.

The whole point of risk-free investments is to avoid market risk.

Yes, that insurance policy costs money, like all insurance does.

I'm willing to draw the line at 0% real returns as 'good enough'.
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Re: Smarter approach to "emergency funds"?

Post by KlangFool » Wed Mar 25, 2020 10:59 am

OP,

I would offer a counterpoint to your idea.

In my opinion, my cash/cash equivalent serves another purpose besides an emergency fund. It is a separate asset class by itself. It helps/protects me from short-term deflation.

Diversification is a good thing.

KlangFool

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Re: Smarter approach to "emergency funds"?

Post by ChrisBenn » Wed Mar 25, 2020 11:12 am

I did this a little over a year ago with an ETF called SWAN - and have been very satisfied with the decision; I did exactly what you suggested - over-funded it by what I expected the worst case drop would be (in this case it's an initial (at rebalance) 90/10 mix of treasuries/spy leaps, so I just assumed the leaps would go to 0).

For the emergency fund portion though I would strongly prefer to have something that was stocks/treasuries, instead of stock/mix(corporate/treasuries) -- I don't know if there are any balanced funds that offer that.

I found a bit more than one months average in the checking account was more convenient -- but it probably depends on how variable your monthly purchases are. I didn't want to treat the fund as a reserve to replenish large purchases, but ideally as something I never touch (if everything works as expected), so ~3 months liquid in checking has worked much better for me. As you point out though, that's going to depend on people's individual circumstances. I would argue that sizing your buffer (liquid cash/equivalent) so you never touch the emergency fund (normally) is probably ideal behaviorally.

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Re: Smarter approach to "emergency funds"?

Post by whodidntante » Wed Mar 25, 2020 11:29 am

What I can't figure out is why rich people want to coddle a separate bucket of money. It's simpler and likely to lead to better returns if you manage risk and tax efficiency across your portfolio. So change your thinking is my advice.

If you're in a situation where it's easy to overextend yourself following a financial shock, by all means, set some money aside to abate that. And then I would agree with vineviz's recommendation to take some risk with that money. Safety can cost quite a lot over a lifetime.

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Re: Smarter approach to "emergency funds"?

Post by rascott » Wed Mar 25, 2020 11:38 am

This seems like bucketing to me..... one bucket in a 20/80 AA.... and another bigger bucket in your "normal" AA. Why not just adjust the overall AA to match this?

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Re: Smarter approach to "emergency funds"?

Post by ChrisBenn » Wed Mar 25, 2020 11:52 am

I think it's definitely bucketing -- I don't think that's a bad thing though (non-optimal for certain definitions of utility, sure -- but so is that last starbucks you had)

There's an investing lifecycle component here though -- if you are just starting out / have a smaller taxable investment then you can't really blend it together without putting your emergency fund (and the rest of your savings) at risk. I think keeping them separate at this point absolutely makes sense. If you blended them together, and say your EF was ~ to your taxable investment, your understandably aggressive 90/10 might have to go to a 50/50 or something. And you now have also end up having to glidepath yourself as you make contributions back up to your aggressive target AA. That seems needlessly complex as compared to bucketing. (I think it's evident why putting your EF in a 90/10 is obviously a bad idea, as well as why a new investor might start out more heavily in stocks)

Once you are to a point where your EF is a small percentage of your taxable savings then sure, you can absorb the hit (hit == withdrawing in a time of high volatility) - but at that point the extra value (overall worth) you get from rolling that into your AA is also pretty small, percentage wise. So also a meh. But at this point I think either is fine - since it doesn't really matter much.

Adjusting your overall AA to match your EF included risk tolerance seems like mental gymnastics to avoid bucketing, and not really adding any value. If rolling your EF into your AA is going to force you to adjust it it seems to me to be a great argument for bucketing. (Not because the overall portfolio is any different, but because you now have to re-adjust your AA as you contribute, since your EF proportion becomes smaller -- why bother with that?)
Last edited by ChrisBenn on Wed Mar 25, 2020 11:55 am, edited 1 time in total.

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Re: Smarter approach to "emergency funds"?

Post by ScubaHogg » Wed Mar 25, 2020 11:52 am

rascott wrote:
Wed Mar 25, 2020 11:38 am
This seems like bucketing to me..... one bucket in a 20/80 AA.... and another bigger bucket in your "normal" AA. Why not just adjust the overall AA to match this?
Because the emergency fund “bucket” can stay close to one $ size forever (in real terms), whereas the more normal investment “bucket” can get bigger and bigger. It’s easier mentally and account-management wise to separate them. Otherwise, as your investment “bucket” keeps growing, you’ll have to continuously make small changes to your overall AA to keep the “right” amount available for emergencies.
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Re: Smarter approach to "emergency funds"?

Post by watchnerd » Wed Mar 25, 2020 11:54 am

rascott wrote:
Wed Mar 25, 2020 11:38 am
This seems like bucketing to me..... one bucket in a 20/80 AA.... and another bigger bucket in your "normal" AA. Why not just adjust the overall AA to match this?
That's what I do.

It's all one AA to me.

My "EF" is just a subset of my fixed income.
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Re: Smarter approach to "emergency funds"?

Post by watchnerd » Wed Mar 25, 2020 11:58 am

ScubaHogg wrote:
Wed Mar 25, 2020 11:52 am

Because the emergency fund “bucket” can stay close to one $ size forever (in real terms), whereas the more normal investment “bucket” can get bigger and bigger. It’s easier mentally and account-management wise to separate them. Otherwise, as your investment “bucket” keeps growing, you’ll have to continuously make small changes to your overall AA to keep the “right” amount available for emergencies.
I put it as part of my bond barbell.

Cash / MM is a 0 duration bond.

I lump it in the short end with Short TIPS (see sig).
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Re: Smarter approach to "emergency funds"?

Post by FelixTheCat » Wed Mar 25, 2020 12:09 pm

Mine is in Vanguard's Short-Term Bond fund. 70% treasuries (for times like now) 30% corporate (when there isn't a crisis). Still up 1.05%.
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Re: Smarter approach to "emergency funds"?

Post by vineviz » Wed Mar 25, 2020 12:15 pm

watchnerd wrote:
Wed Mar 25, 2020 10:49 am
Why not short TIPS instead of cash / T-bills?
Short-term TIPS have done marginally better than cash, but still lost purchasing power since 2009.

Struggling to post a screenshot at the moment, but here's a link: https://www.portfoliovisualizer.com/bac ... ion3_3=100
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Re: Smarter approach to "emergency funds"?

Post by BogleMelon » Wed Mar 25, 2020 12:19 pm

vineviz wrote:
Wed Mar 25, 2020 10:19 am
Or, rather, inflation is the true enemy of cash.

$10,000 placed in Treasury bills at the end of 2008 has LOST 15% of its purchasing power since then. Put another way, if $10,000 was six months worth of expenses in 2009, your emergency fund is down to just five months now.
I bonds.
Problem solved
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Re: Smarter approach to "emergency funds"?

Post by vineviz » Wed Mar 25, 2020 12:24 pm

whodidntante wrote:
Wed Mar 25, 2020 11:29 am
What I can't figure out is why rich people want to coddle a separate bucket of money. It's simpler and likely to lead to better returns if you manage risk and tax efficiency across your portfolio. So change your thinking is my advice.

If you're in a situation where it's easy to overextend yourself following a financial shock, by all means, set some money aside to abate that. And then I would agree with vineviz's recommendation to take some risk with that money. Safety can cost quite a lot over a lifetime.
I agree that most investors with ample investments in a taxable account (say, >1x annual spending) likely don't need a separate bucket for "emergency funds". They are likely to weather most typical financial shocks adequately at that point.

For many households, however,, there's a long gap in time between first building an emergency fund and finally accumulating enough wealth to justify additional taxable investments. Typically households move through the process capturing their maximum 401(k) match, funding Roth IRAs (if available) and traditional IRAs, 529 plans if they have children, etc.

Having a dedicated bucket for "emergency funds" is mental accounting for households in this gap, for sure, but it can be a useful version of mental accounting.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Smarter approach to "emergency funds"?

Post by Jags4186 » Wed Mar 25, 2020 12:25 pm

OP,

Your assessment basically boils down to invest your emergency fund in bonds vs cash. Since bonds can go down, this doesn't make sense. That 7th month of the emergency fund money can be invested in your regular portfolio to whatever asset allocation you want. You are free to invest it 100% in equities.

At least right now and for the last 10 years, a sizeable emergency fund ($50k or less), in cash, can easily generate 5%+ for absolutely 0 risk if you're willing to open a few savings accounts throughout the year. Right now my wife and I have two $25,000 CDs paying 1.75% at Ally and we'll each get $250 bonus for holding that money in there for 3 months. That gives us a 5.75% return for 3 months. At the end of the 3 month period we'll jump into another deal elsewhere. Last year $50,000 generated us over $8,000 in interest (just did my taxes so I know this).

Your example shows the emergency funding inflation-adjusted tripling over 25 years. If my emergency fund got too big I would shift that excess to my main portfolio. Therefore all that compound emergency fund growth you're showing doesn't actually exist.

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Re: Smarter approach to "emergency funds"?

Post by vineviz » Wed Mar 25, 2020 12:29 pm

BogleMelon wrote:
Wed Mar 25, 2020 12:19 pm
vineviz wrote:
Wed Mar 25, 2020 10:19 am
Or, rather, inflation is the true enemy of cash.

$10,000 placed in Treasury bills at the end of 2008 has LOST 15% of its purchasing power since then. Put another way, if $10,000 was six months worth of expenses in 2009, your emergency fund is down to just five months now.
I bonds.
Problem solved
It's better than cash, for sure.

But I'd prefer a 3% real return to a 0.8% real return. Can't speak for anyone else.
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Re: Smarter approach to "emergency funds"?

Post by MathWizard » Wed Mar 25, 2020 12:30 pm

I completely agree with the OP.

My emergency fund is just a cash flow fund, on average about 3 month's expenses, but
it is what manages those things that I really don't consider emergencies, since I know that
they will happen, I just don't know when.

I know I will need to replace appliances, water heater, furnace, cars, but I don't know exactly when.
I average the costs out and have that money set aside for when I might expect such expenses to occur,
with a small amount extra to account for variation.

The only case where I would need to pull from my portfolio would be in truly unusual events:
A series of big expenses close together: Within 3 months: Expensive vacation, the car dies, then an expensive house repair.
Lose my job with little hope of another anytime soon.

The risk is small in any one time. By allowing the 2nd tier EF to grow beyond inflation the money is there if needed
unless you are very unlucky. But to guard against that rare an event by losing out on so much gain, is like buying very
expensive insurance.

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Re: Smarter approach to "emergency funds"?

Post by alluringreality » Wed Mar 25, 2020 12:32 pm

Since VASIX is just four total market funds, this generally amounts to rolling an emergency fund into a portfolio. Essentially someone would be choosing to accept near-term volatility, such as recent losses, in exchange for potentially higher long-term returns. Considering how much difference there is between bond yield from 1995 and today, and I figure there are practical limits to negative yields, I tend to question if the next 25 years will necessarily resemble the graph from the past 25 years. I have decided to roll my emergency fund into my portfolio, yet with the US recently being willing to trend toward world rates, I fail to see how investing nearly 1/4 of my emergency fund into international bonds is necessarily smarter than other options available to individual investors.
vineviz wrote:
Wed Mar 25, 2020 12:29 pm
But I'd prefer a 3% real return to a 0.8% real return. Can't speak for anyone else.
I'm not sure what this is based around, but the 2020 brokerage outlooks generally did not support the idea of receiving a 3% real return for the next decade from 20% stocks and 80% bonds.
Last edited by alluringreality on Wed Mar 25, 2020 1:14 pm, edited 3 times in total.

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Re: Smarter approach to "emergency funds"?

Post by vineviz » Wed Mar 25, 2020 12:34 pm

Jags4186 wrote:
Wed Mar 25, 2020 12:25 pm
Right now my wife and I have two $25,000 CDs paying 1.75% at Ally and we'll each get $250 bonus for holding that money in there for 3 months. That gives us a 5.75% return for 3 months. At the end of the 3 month period we'll jump into another deal elsewhere.
Sounds like an interesting hobby, but it's a level of active management/musical chairs that doesn't appeal to everyone.

My post is aimed at people who possibly don't have so much time on their hands.
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Re: Smarter approach to "emergency funds"?

Post by willthrill81 » Wed Mar 25, 2020 12:35 pm

KlangFool wrote:
Wed Mar 25, 2020 10:59 am
OP,

I would offer a counterpoint to your idea.

In my opinion, my cash/cash equivalent serves another purpose besides an emergency fund. It is a separate asset class by itself. It helps/protects me from short-term deflation.

Diversification is a good thing.

KlangFool
Nominal bonds provide protection from deflation.
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Re: Smarter approach to "emergency funds"?

Post by watchnerd » Wed Mar 25, 2020 12:35 pm

vineviz wrote:
Wed Mar 25, 2020 12:15 pm
watchnerd wrote:
Wed Mar 25, 2020 10:49 am
Why not short TIPS instead of cash / T-bills?
Short-term TIPS have done marginally better than cash, but still lost purchasing power since 2009.

Struggling to post a screenshot at the moment, but here's a link: https://www.portfoliovisualizer.com/bac ... ion3_3=100
I'm okay with that tradeoff vs the -12 - -13% drawdown the LifeStrategy combo shows in 2009.

I'll pay the price of a little inflation erosion (and short TIPS makes that erosion not so bad) for something that shields from that.

That's kind of the point of emergency money, in my mind.

Having one thing that doesn't tank in bad times is important to me.
Last edited by watchnerd on Wed Mar 25, 2020 12:42 pm, edited 1 time in total.
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Re: Smarter approach to "emergency funds"?

Post by willthrill81 » Wed Mar 25, 2020 12:36 pm

vineviz wrote:
Wed Mar 25, 2020 10:19 am
Slightly overfund the emergency fund and invest it in a very conservative balanced fund (e.g. a fund that is 20% to 30% stocks) such as the Vanguard LifeStrategy Income Fund (VASIX).
I entirely agree and have made a similar recommendation myself before. Back when we still had an EF of some size (we no longer have a real need for one), we invested 2/3 of it in Wellesley Income fund and left the remainder in hard cash stored securely.
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Re: Smarter approach to "emergency funds"?

Post by willthrill81 » Wed Mar 25, 2020 12:40 pm

rascott wrote:
Wed Mar 25, 2020 11:38 am
This seems like bucketing to me..... one bucket in a 20/80 AA.... and another bigger bucket in your "normal" AA. Why not just adjust the overall AA to match this?
'Buckets' aren't really 'buckets' if there is no rebalancing occurring between them. For instance, if I won't rebalance from my EF to my portfolio, then it's not just mental accounting.

That said, if you have enough accessible relatively non-volatile bonds (e.g. Treasuries, not junk bonds), I would argue that you don't need an EF at all.
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Re: Smarter approach to "emergency funds"?

Post by Unladen_Swallow » Wed Mar 25, 2020 12:45 pm

Savings account.
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Re: Smarter approach to "emergency funds"?

Post by watchnerd » Wed Mar 25, 2020 12:51 pm

willthrill81 wrote:
Wed Mar 25, 2020 12:40 pm

That said, if you have enough accessible relatively non-volatile bonds (e.g. Treasuries, not junk bonds), I would argue that you don't need an EF at all.
+1

Our "virtual emergency fund" is just the short end of our bond barbell.

Or, in Sharpe terms, the short end of our bond barbell is in the 'risk free' port.

The long end is in the 'risky' port.
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Re: Smarter approach to "emergency funds"?

Post by frand » Wed Mar 25, 2020 12:55 pm

Personally, I find it mentally hard for me to invest emergency funds in any stocks. I would rather increase stock allocation in my retirement savings.

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Re: Smarter approach to "emergency funds"?

Post by Bryzzo2016 » Wed Mar 25, 2020 12:56 pm

Mine's in VTSAX. Seemed like a great strategy until 3 weeks ago.

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Re: Smarter approach to "emergency funds"?

Post by 9-5 Suited » Wed Mar 25, 2020 1:03 pm

For me the thing that cuts through this, but is philosophically aligned to the OP’s proposal, is to just treat asset allocation/location decisions holistically across the portfolio including whatever dedication one wants to short -term assets like cash or short bonds. Seems easier that having VASIX separately constructed for the purpose of an emergency fund.

But that said, I do agree it’s a simple heuristic for most people to follow and keeping that money separate may encourage keeping one’s hands off of it. So likely a wise choice for many.

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Re: Smarter approach to "emergency funds"?

Post by Hector » Wed Mar 25, 2020 1:09 pm

Some of us don't have separate emergency funds.
In that scenario, when you rebalance from bond to stock in the crash, make sure that bonds stay at a certain amount(emergency fund). This works with very conservation bond selection. People with total bonds and long term bonds would need a bigger cushion as they are more volatile.

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Re: Smarter approach to "emergency funds"?

Post by Blue456 » Wed Mar 25, 2020 2:18 pm

vineviz wrote:
Wed Mar 25, 2020 10:19 am

Even if you were INSANELY unlucky and invested at a market peak, an immediate 15% drop would still leave you with more than six months worth of expenses if you were again INSANELY unlucky enough to need the money right at the market bottom.
I did that January 2nd 2020. I place 50% of my emergency fund into Wellesley Income Fund. The other 50% in cash.

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Re: Smarter approach to "emergency funds"?

Post by Thesaints » Wed Mar 25, 2020 2:22 pm

Whoever has enough money does not need an emergency fund.

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Re: Smarter approach to "emergency funds"?

Post by watchnerd » Wed Mar 25, 2020 2:25 pm

Thesaints wrote:
Wed Mar 25, 2020 2:22 pm
Whoever has enough money does not need an emergency fund.
True, but one always needs liquidity.

And optionality can be nice for tax purposes.
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Re: Smarter approach to "emergency funds"?

Post by lostdog » Wed Mar 25, 2020 2:47 pm

If we have 11x our expenses in taxable but it's in Total US and Total International, do we need an emergency fund or am I wasting away the 6 months in cash?

I always struggle with this.
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Triple digit golfer
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Re: Smarter approach to "emergency funds"?

Post by Triple digit golfer » Wed Mar 25, 2020 2:53 pm

No one needs an emergency fund, but everyone needs an emergency plan.

For some, that is a separate emergency fund in a savings or other FDIC insured account, totally separate from their AA.

For others, it means a more conservative AA, but no separate account. The bond portion of the AA would serve as an emergency fund.

I suspect that many (most?) probably do a combination of the above. That is, maybe a few months (3-6?) of cash savings, and after that their bond portion is their emergency fund. This is how we currently do it. The rationale is that most emergencies aren't going to last years, and so I'm not planning that way. However, very important, if it did happen, I can still withstand it by using my bond portfolio. In a true emergency, though, the entire AA is fair game.

For even others, who are more risky and feel an emergency is highly unlikely, maybe they'll be 100/0 and still have no emergency fund, deciding that over decades of investing, the increased return of equities will more than make up for any potential emergency they may have. They're happy to plan to sell equities at whatever the current price is if they need the funds.

I don't really understand the concept of "just have a slightly large emergency fund than needed and put some of it in equities." What does that mean? For a desired 6 month emergency fund, forego a month of expenses worth of investing and put it in the 20/80 emergency fund so that it's now 7 months? Why not just invest that month into your regular AA and leave the 6 months at 100% cash/bonds? In the event of an emergency lasting longer than six months, you tap into the portfolio anyway. Six of one, half dozen of another.

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watchnerd
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Re: Smarter approach to "emergency funds"?

Post by watchnerd » Wed Mar 25, 2020 3:00 pm

Triple digit golfer wrote:
Wed Mar 25, 2020 2:53 pm


I don't really understand the concept of "just have a slightly large emergency fund than needed and put some of it in equities." What does that mean? For a desired 6 month emergency fund, forego a month of expenses worth of investing and put it in the 20/80 emergency fund so that it's now 7 months? Why not just invest that month into your regular AA and leave the 6 months at 100% cash/bonds? In the event of an emergency lasting longer than six months, you tap into the portfolio anyway. Six of one, half dozen of another.
I struggled with the same concept.

I realized it only made sense to me if one considers the emergency money to be completely firewalled from the rest of the portfolio.

Whereas, like you, I just think of emergency monies as part of the asset continuum in aggregate.
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BogleMelon
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Re: Smarter approach to "emergency funds"?

Post by BogleMelon » Wed Mar 25, 2020 3:10 pm

vineviz wrote:
Wed Mar 25, 2020 12:29 pm
BogleMelon wrote:
Wed Mar 25, 2020 12:19 pm
vineviz wrote:
Wed Mar 25, 2020 10:19 am
Or, rather, inflation is the true enemy of cash.

$10,000 placed in Treasury bills at the end of 2008 has LOST 15% of its purchasing power since then. Put another way, if $10,000 was six months worth of expenses in 2009, your emergency fund is down to just five months now.
I bonds.
Problem solved
It's better than cash, for sure.

But I'd prefer a 3% real return to a 0.8% real return. Can't speak for anyone else.
And I'd prefer ~6% (100% stocks). But can I do that with my EF? Stocks and bonds don't come risk-free. EF in cash has inflation risk as you stated. I bonds eliminate that risk.
"One of the funny things about stock market, every time one is buying another is selling, and both think they are astute" - William Feather

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willthrill81
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Re: Smarter approach to "emergency funds"?

Post by willthrill81 » Wed Mar 25, 2020 3:13 pm

watchnerd wrote:
Wed Mar 25, 2020 3:00 pm
Triple digit golfer wrote:
Wed Mar 25, 2020 2:53 pm


I don't really understand the concept of "just have a slightly large emergency fund than needed and put some of it in equities." What does that mean? For a desired 6 month emergency fund, forego a month of expenses worth of investing and put it in the 20/80 emergency fund so that it's now 7 months? Why not just invest that month into your regular AA and leave the 6 months at 100% cash/bonds? In the event of an emergency lasting longer than six months, you tap into the portfolio anyway. Six of one, half dozen of another.
I struggled with the same concept.

I realized it only made sense to me if one considers the emergency money to be completely firewalled from the rest of the portfolio.

Whereas, like you, I just think of emergency monies as part of the asset continuum in aggregate.
emphasis added

Precisely. For young accumulators with small portfolios, this should likely be true. But for older accumulators with significant portfolios, it likely isn't true.
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ChrisBenn
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Re: Smarter approach to "emergency funds"?

Post by ChrisBenn » Wed Mar 25, 2020 3:14 pm

watchnerd wrote:
Wed Mar 25, 2020 3:00 pm
Triple digit golfer wrote:
Wed Mar 25, 2020 2:53 pm


I don't really understand the concept of "just have a slightly large emergency fund than needed and put some of it in equities." What does that mean? For a desired 6 month emergency fund, forego a month of expenses worth of investing and put it in the 20/80 emergency fund so that it's now 7 months? Why not just invest that month into your regular AA and leave the 6 months at 100% cash/bonds? In the event of an emergency lasting longer than six months, you tap into the portfolio anyway. Six of one, half dozen of another.
I struggled with the same concept.

I realized it only made sense to me if one considers the emergency money to be completely firewalled from the rest of the portfolio.

Whereas, like you, I just think of emergency monies as part of the asset continuum in aggregate.

If your option is just "store it in your AA" then this is reasonable if the size of your taxable savings is much greater than your emergency fund. Consider a saver starting out with 30k in taxable (90/10) and 30k in an emergency fund. Obviously storing that in the AA would be a bad idea. You could of course adjust your overall AA - if you wanted 10/90 for your emergency fund then a 50/50 would do it. BUT, now next paycheck/contribution you have to re-target your AA for a new balance since you have 30k(ef) + 30k+contribution(investments). with different implicit risk tolerances/horizons.

Once your AA gets large enough that the fixed income portion alone covers your emergency fund than sure, it doesn't matter.

MathWizard
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Re: Smarter approach to "emergency funds"?

Post by MathWizard » Wed Mar 25, 2020 3:15 pm

Triple digit golfer wrote:
Wed Mar 25, 2020 2:53 pm
...

I don't really understand the concept of "just have a slightly large emergency fund than needed and put some of it in equities." What does that mean? For a desired 6 month emergency fund, forego a month of expenses worth of investing and put it in the 20/80 emergency fund so that it's now 7 months? Why not just invest that month into your regular AA and leave the 6 months at 100% cash/bonds? In the event of an emergency lasting longer than six months, you tap into the portfolio anyway. Six of one, half dozen of another.
I agree if the 6 month 7th month split was 6 months of bonds and the 7th all stocks (close enough to 20/80).
I believe OP was not arguing against that, but against the 6 months being cash for the truly rare events.

The cash OP recommended was the amount for expected but irregular expenses (appliance replacement for example)
The rest would be your 6 months bonds, one month stocks AA, for a 2nd tier EF.

Assuming the OPs numbers are correct with a 3.4% greater growth than cash, and with annual expenses of $80K,
(6 months expenses = $40K) then after 30 years, this amounts to $109K, inflation adjusted, for a (real) gain of over $69K
compared to using cash for the 6 months cash part of the EF.

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Re: Smarter approach to "emergency funds"?

Post by Unladen_Swallow » Wed Mar 25, 2020 3:18 pm

lostdog wrote:
Wed Mar 25, 2020 2:47 pm
If we have 11x our expenses in taxable but it's in Total US and Total International, do we need an emergency fund or am I wasting away the 6 months in cash?

I always struggle with this.
If the stocks fall by 50%, how many times expenses will you have? It's a rhetorical question.

Emergency fund is often needed at times when your job and stocks are both down. 2000, 2008, 2020....
If you have a large taxable account that could fall from $2million to $1 million, and you would be happy withdrawing from it to live, then that is fine.

Emergency Fund for me is intended to be risk free. Because I will most likely need it when risk shows up in all other aspects of life.
"I think it's much more interesting to live not knowing than to have answers which might be wrong." - Richard Feynman

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Re: Smarter approach to "emergency funds"?

Post by lostdog » Wed Mar 25, 2020 3:20 pm

Unladen_Swallow wrote:
Wed Mar 25, 2020 3:18 pm
lostdog wrote:
Wed Mar 25, 2020 2:47 pm
If we have 11x our expenses in taxable but it's in Total US and Total International, do we need an emergency fund or am I wasting away the 6 months in cash?

I always struggle with this.
If the stocks fall by 50%, how many times expenses will you have? It's a rhetorical question.

Emergency fund is often needed at times when your job and stocks are both down. 2000, 2008, 2020....
If you have a large taxable account that could fall from $2million to $1 million, and you would be happy withdrawing from it to live, then that is fine.

Emergency Fund for me is intended to be risk free. Because I will most likely need it when risk shows up in all other aspects of life.
Thanks
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Triple digit golfer
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Re: Smarter approach to "emergency funds"?

Post by Triple digit golfer » Wed Mar 25, 2020 3:32 pm

willthrill81 wrote:
Wed Mar 25, 2020 3:13 pm
watchnerd wrote:
Wed Mar 25, 2020 3:00 pm
Triple digit golfer wrote:
Wed Mar 25, 2020 2:53 pm


I don't really understand the concept of "just have a slightly large emergency fund than needed and put some of it in equities." What does that mean? For a desired 6 month emergency fund, forego a month of expenses worth of investing and put it in the 20/80 emergency fund so that it's now 7 months? Why not just invest that month into your regular AA and leave the 6 months at 100% cash/bonds? In the event of an emergency lasting longer than six months, you tap into the portfolio anyway. Six of one, half dozen of another.
I struggled with the same concept.

I realized it only made sense to me if one considers the emergency money to be completely firewalled from the rest of the portfolio.

Whereas, like you, I just think of emergency monies as part of the asset continuum in aggregate.
emphasis added

Precisely. For young accumulators with small portfolios, this should likely be true. But for older accumulators with significant portfolios, it likely isn't true.
Agreed 100%.

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HanSolo
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Re: Smarter approach to "emergency funds"?

Post by HanSolo » Wed Mar 25, 2020 3:32 pm

vineviz wrote:
Wed Mar 25, 2020 10:19 am
The thing I want to explore here is HOW/WHERE the emergency fund should be saved/invested.
If the purpose is to get more yield than from CDs or money market, I see nothing wrong with using funds like Short-Term Treasury or Short-Term Federal. Ultra-Short-Term is also interesting, if you don't mind a focus on AAA corporates rather than government bonds.

Perhaps this is a matter of personal taste (in terms of how much potential volatility you're willing to take, etc.).

Triple digit golfer
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Re: Smarter approach to "emergency funds"?

Post by Triple digit golfer » Wed Mar 25, 2020 3:33 pm

Unladen_Swallow wrote:
Wed Mar 25, 2020 3:18 pm
lostdog wrote:
Wed Mar 25, 2020 2:47 pm
If we have 11x our expenses in taxable but it's in Total US and Total International, do we need an emergency fund or am I wasting away the 6 months in cash?

I always struggle with this.
If the stocks fall by 50%, how many times expenses will you have? It's a rhetorical question.

Emergency fund is often needed at times when your job and stocks are both down. 2000, 2008, 2020....
If you have a large taxable account that could fall from $2million to $1 million, and you would be happy withdrawing from it to live, then that is fine.

Emergency Fund for me is intended to be risk free. Because I will most likely need it when risk shows up in all other aspects of life.
If you don't mind me asking, what is your approximate portfolio size in terms of annual expenses? What is your AA and how large is your separate emergency fund?

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Re: Smarter approach to "emergency funds"?

Post by The Broz » Wed Mar 25, 2020 3:55 pm

I liked the idea that I came across a month or two ago. My understanding was that Taylor advocated for a two fund portfolio in taxable where the Total Bond Market was what you could not afford to lose and VTSAX (or maybe it was Total World) was everything else. Please correct me if I am off base.

We are extremely cash heavy at the moment in preparation for a house purchase, but I was thinking of doing something along those lines after we purchase. I was thinking of doing a no penalty CD for the 6 months of expenses, then surplus money each month goes into Total Bond and VTSAX in some ratio until Total Bond reaches another 3 months of expenses (so a total of 9 months of expenses for EF). Once that is achieved, everything goes into VTSAX. So Total Bond would be sort of a first layer of defense, but we can take advantage of some gains without feeling like we are being too risky with the EF. Or we might use the Total Bond money as a surplus EF and a fund for major purchases at the same time.

The OP started off with something that seemed crazy to me, but reading further, does make an interesting point. I do enjoy these sorts of discussions. Someone also mentioned I Bonds, which I confess I know nothing about. But now I have something to research! :wink:

mega317
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Re: Smarter approach to "emergency funds"?

Post by mega317 » Wed Mar 25, 2020 4:11 pm

willthrill81 wrote:
Wed Mar 25, 2020 12:36 pm
Back when we still had an EF of some size (we no longer have a real need for one), we invested 2/3 of it in Wellesley Income fund and left the remainder in hard cash stored securely.
That's right, I remember you posting about physical cash in the past. When you paid off your house did you dig all that up and send it to Vanguard?
https://www.bogleheads.org/forum/viewtopic.php?t=6212

mega317
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Re: Smarter approach to "emergency funds"?

Post by mega317 » Wed Mar 25, 2020 4:13 pm

lostdog wrote:
Wed Mar 25, 2020 2:47 pm
If we have 11x our expenses in taxable but it's in Total US and Total International, do we need an emergency fund or am I wasting away the 6 months in cash?

I always struggle with this.
If you have 11x expenses in taxable then your 6 months in cash are 4% of your taxable account and likely much less than 4% of your whole portfolio. It doesn't matter what you do. That's probably why you struggle.
https://www.bogleheads.org/forum/viewtopic.php?t=6212

Coltrane75
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Re: Smarter approach to "emergency funds"?

Post by Coltrane75 » Wed Mar 25, 2020 4:13 pm

If you can afford loss beyond a certain amount; then that excess amount is IMO no longer emergency fund money. It may well be short to mid term investment/savings. But I don't think that is emergency money anymore.

Why not just earmark 6 months of expenses as emergency, then a certain amount aside from that for investments of a short-mid duration?

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