Smarter approach to "emergency funds"?

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MoneyMarathon
Posts: 927
Joined: Sun Sep 30, 2012 3:38 am

Re: Smarter approach to "emergency funds"?

Post by MoneyMarathon » Thu Mar 26, 2020 4:57 pm

Jags4186 wrote:
Thu Mar 26, 2020 7:50 am
My $50k got me over the same time period earned me $16,144.72 in interest
At 43% marginal rates, that interest would be only $9k.

Hard for me to get excited about bank bonuses, between the work (which is real) and the taxes.

Jags4186
Posts: 4358
Joined: Wed Jun 18, 2014 7:12 pm

Re: Smarter approach to "emergency funds"?

Post by Jags4186 » Thu Mar 26, 2020 5:02 pm

MoneyMarathon wrote:
Thu Mar 26, 2020 4:57 pm
Jags4186 wrote:
Thu Mar 26, 2020 7:50 am
My $50k got me over the same time period earned me $16,144.72 in interest
At 43% marginal rates, that interest would be only $9k.

Hard for me to get excited about bank bonuses, between the work (which is real) and the taxes.
If I were in a 43% marginal tax bracket I would care much less about the interest earnings of my emergency fund and worry much more about counting all the bucks I was making.

Starfish
Posts: 1659
Joined: Wed Aug 15, 2018 6:33 pm

Re: Smarter approach to "emergency funds"?

Post by Starfish » Thu Mar 26, 2020 5:36 pm

ChrisBenn wrote:
Thu Mar 26, 2020 4:41 pm
Starfish wrote:
Thu Mar 26, 2020 3:42 pm
ChrisBenn wrote:
Thu Mar 26, 2020 9:14 am
Starfish wrote:
Thu Mar 26, 2020 2:49 am
ChrisBenn wrote:
Wed Mar 25, 2020 5:56 pm


If by AA you mean "allocation I have determined based on risk tolerance, investment horizon, etc" - then that will typically be slated to a retirement goal (at list that's the assumption I'm working with here). The risk tolerance/investment horizon for an EF are probably different.

So now you have to determine what your new target AA should be based on two factors - EF usage, and retirement. It's hard enough to do it based on one - blurring two almost opposing use cases is just going to blur the AA/risk tolerance estimate more.

And, ultimately, if you nailed it, the AA would effectively be the same as your overall (as measured AA) with an appropriate emergency fund + retirement taxable. It actually seems more likely to produce a correct outcome to estimate each independently. At that point averaging them together with a fund size weight gives you your new target AA - but you now should reset that each time you contribute (since the EF is more of a fixed and not percentage allocation).

Or you can just ignore all of that and keep it in two funds; that actually seems much simpler to me?

As mentioned before, if your taxable is so much greater than your emergency fund that the inclusion of the latter doesn't move the needle on desired AA then sure, roll it together (but honestly at that point it doesn't matter much what you do). But for people who aren't at that point the bucketing approach still seems much easier/simpler. (Unless you consider your risk tolerance/investment horizon the exact same for a EF vs. your retirement taxable)

I still don't understand why bother to add stocks to your EF and then inflate it, when you could use a an appropriate risk allocation and use the additional money to add to your main AA (retirement targeted).
What stops your from having a 3 portion AA (stocks, long term bonds and short term investments) and sell them accordingly when the need appears. If one asset is down sell the other... it goes in the direction of rebalancing.
How would that work if a persons taxable savings was 30k (with a 30 year investment horizon) and their ef was 30k?

You would have to adjust your overall AA to manage risk - and every time you contribute to your savings (with a longer investment horizon than the ef) you would have go recompute your target aa. If you bucketed the two funds this would happen implicitly.

Once your EF does't move the needle on your savings AA (when the latter is much larger) then that strat is fine if one prefers it - doesn't make a big difference either way at that point.
So the problem is the obsession over AA? AA is a guideline. It should change as your conditions change (and if market changes if you ask me).
Is it that hard to have an AA made of 30K cash and 70/30 for the rest? You fill the EF part and then keep contributing to the LT one.
Even the partition EF/LT is also mental accounting. There are 3 asset classes and all of them can be used in an emergency, not only the cash. If I were laid off 3 months ago I would have sold stocks because they were very appreciated instead of using the cash. Now I might use cash because stocks are down.
I think keeping the EF as a separate bucket (when it's not a trivial percentage of your retirement taxable assets) makes sense, no disagreement there. I think the 30k as cash, and a retirement horizon AA for the rest is great as a default/baseline.

So then we come to the proposition brought up by vinevize, using a conservative asset allocation for your EF (potentially with slight overfunding to account for volatility) - this could be considered a potential evolution of the the above. There are tradeoffs there, so it's not for everyone, but I think there are valid arguments for it (that were laid out in the op)

My only point of argument with the discussion here (and apologies if I misinterpreted your post) was the notion that it makes more sense to roll some or all of the EF into your retirement AA. For people with a 5 figure EF and 7 figure taxable retirement AA absolutely that's fine. But if you are in the early accumulation stage I believe it's just much simpler to bucket it. Consider a person who wanted a 20/80 AA for their EF (30k), and a 90/10 allocation for their retirement taxable AA (30k). So they start out with 6k equities / 24k bonds for the EF and 27k equities / 3k bonds for retirement. Or 33k/27k. Now their next paycheck comes in, what do they purchase to maintain their AA? As part of the calculations you have to back out the 20/80 (30k) EF portion first. Pretty trivial sure, but just seems pointless you you can keep it in two separate buckets to begin with?

I agree,not a big difference, but I wasn't arguing it was wrong, I was arguing that the bucketing approach wasn't wrong.
The bucketing approach is not wrong, it's just a matter of methodology and lack of clarity.
What is wrong is investing in LT assets (stocks) for unknown (short?) term purposes (EF). EF is not even a short term fund. Many people probably never or rarely use it.
They way I look at this is 3 classes of assets with different trade off between risk and expected returns.
When I need to sell, it could be tomorrow or 30 years from now, I sell what is convenient to sell to minimize the drawdown. If 2 LT assets are down I still have the cash.
When you start it is wiser (more conservative) to start from the least risky category (cash), as most people naturally do anyway.

socialforums2019
Posts: 46
Joined: Sun Aug 25, 2019 10:12 am

Re: Smarter approach to "emergency funds"?

Post by socialforums2019 » Sun Mar 29, 2020 9:12 am

This has been an eye-opening thread for me.

I have 6 figures in cash sitting in a 1.7% high int savings account. A part of those 6 figures, is a 5 figure 6-mo emergency fund. With the feds dropping the interest rates, I anticipate the high int savings accounts to soon follow.

I feel as though I have a few options

1. Open 3-4 penalty free CDs @ 1.7% which will protect my interest for 7-12 months
2. Open a few CDs @ 1.85% which will protect my interest for 12 months, but the cash is now locked up

I am now considering this option where I will take 7 months of emergency funds and place it into VASIX and then the rest in option 1 or 2. I can always put a stop loss @ 10-15% drop to protect the rest of the funds.

mega317
Posts: 3658
Joined: Tue Apr 19, 2016 10:55 am

Re: Smarter approach to "emergency funds"?

Post by mega317 » Sun Mar 29, 2020 9:39 am

socialforums2019 wrote:
Sun Mar 29, 2020 9:12 am
1. Open 3-4 penalty free CDs @ 1.7% which will protect my interest for 7-12 months
2. Open a few CDs @ 1.85% which will protect my interest for 12 months, but the cash is now locked up
This was a decision I was considering. At the amounts I'm working with I preferred the liquidity to 0.15%
I am now considering this option where I will take 7 months of emergency funds and place it into VASIX and then the rest in option 1 or 2. I can always put a stop loss @ 10-15% drop to protect the rest of the funds.
Yes I am a big fan of stocks in taxable, Placing cash needs in a tax-advantaged account, and just making the exchange as the taxable account gets too small for comfort.
https://www.bogleheads.org/forum/viewtopic.php?t=6212

Sandrino
Posts: 4
Joined: Thu May 04, 2017 2:28 pm

Re: Smarter approach to "emergency funds"?

Post by Sandrino » Sun Mar 29, 2020 10:30 am

I agree with OP and even have been following this strategy for a while now there is one aspect of the strategy I would love hear some opinions on.

Specifically, what is the cash out strategy when you actually need a portion of the money?

A while back we needed to use a portion of our emergency fund and we had to cash out a substantial portion of it. We have been making monthly contributions to build it back up - but I have been thinking that we probably should have cashed out the equities before touching the bond portion of the allocation in a fashion that would keep the maximum drown down risk of the EF AA close to whatever buffer you have after the withdrawal.

When we were invested at Betterment before coming over to Vanguard, their recommendation was a 40/60 portfolio with a 30% buffer using the same logic that it would cover you in the case of the worst seen drawdown of the asset allocation.

So perhaps the scale would look something like this:

0% buffer....... ?
10% buffer..... ?
20% buffer.....20/80
30% buffer......40/60

A less sophisticated method may be to cash out the equities before you cash out any bonds - but at what point do you cash it all out and end up back in cash to rebuild or to build it up to begin with.

I would love to hear some thoughts on this.

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