Rethinking emergency funds

[banders]

I don’t want to be that guy, but I’ve been thinking about the emergency fund. I think I should have a million in the bank just in case I need it tomorrow. But even then I’m not sure what I would need money that quickly for. But even if I did, I could use credit card(s).

Having millions in the bank seems a waste with both inflation and lost earnings. I’m thinking it would be better to invest it and sell if I really need it. Include emergency spending in my investments.

I know investments can go down, but they’d go down without that emergency portion and things would be extremely dire if I had to sell all of it. And they may just as easily go up. If I have ¥5m in the bank and an emergency arises in a few years, how much have I lost by keeping it as cash in the meantime? And if I keep a separate fund and spend it, I would need to stop investments to top it up.

This requires the acceptance that I may have to sell some investments, but if I do accept that, is it a bad plan?

I’ve never read anywhere that even suggests this. Any thoughts?

[RetireJapan]

There are different ways to think about emergency funds.

One would be to have a high saving rate: if you only spend half your income each month, that gives you a lot of flexibility.

Another would be access to credit.

Or a spouse who also works.

Or different income streams.

It all boils down to your particular situation, what you think might come up, and feeling comfortable.

[adamu]

Mr Money Mustache agrees it's not necessary.

In my case I save half my income, have half my annual income in credit available, and still have more than a year of expenses in cash. That cash has probably cost me so much in lost gains over the last 10 years, as it was and still is a significant percentage of my net worth, but it's also given me the confidence to consistently save during that period including two market drops, so it's sort of a form of insurance: the price you pay to give you confidence to take a risk (and not sell out) knowing you're covered if the worst happens.

Something about seeing a large number in the bank just gives me so much peace of mind that an investment account doesn't. Plus it gets you on the top tier of most banks, so at least you get free withdrawals and bank transfers without feeling like you're being shaken down for spending your own money.

[TokyoWart]

Like @adamu I find that emergency fund to be a great psychological boost to staying invested during downturns and keeping my asset allocations aggressive (meaning lots of equity index funds instead of bonds). It has definitely cost me money because our interest rates are so low in Japan but I am happy with it. As I'm getting closer to retirement, I can see that the relatively large emergency fund helps the transition to having a large "bucket" of cash to help manage sequence-of-returns risks and especially to pay that first year of 住民税 that will be left over from my salaried employment.

[RetireJapan]

As I'm getting closer to retirement, I can see that the relatively large emergency fund helps the transition to having a large "bucket" of cash to help manage sequence-of-returns risks and especially to pay that first year of 住民税 that will be left over from my salaried employment.

In "retirement" I am definitely warming to the 'mountain of cash' / stock market investments barbell approach.

Feels enormously comforting.

[Butterball]

I’ve come to think of my emergency fund as part of my overall portfolio. Which may seem contradictory, as the whole point of an emergency fund is that it’s separate from your investments.

But here’s how I see it. You have your traditional stocks/bonds target ratio. I think of it as growth/fixed. For me it’s 80/20. The 20% “fixed” is 10% bonds and 10% cash. The 10% cash figure is because that amounted to about what I needed for a good-sized emergency fund when I was figuring all this out. I don’t think of the cash as “doing nothing” because it’s part of that 20% that protects against market volatility. The 10% bonds portion is all developed country ex-Japan funds, and together with the cash being all in yen, also serves as a hedge against currency exchange rate risk.

I’ll likely start ramping up my “fixed” allocation to something more like 70/30 soon; I’ll be increasing the bonds and keeping the cash steady at 10%.

Functionally it amounts to pretty much the same thing as any other emergency fund, but psychologically it really removes the FOMO for me. I feel like I’m fully invested and I’m not going to lose sleep over some slightly better gains I may or not see if some of my 10% cash were allocated into bonds.

[banders]

Many thanks for your replies. Priceless. I’m just thinking it through and different opinions are very useful. I get what you’re all saying and I see your points. It’s like deciding the best allocation on a spider graph. I believe you’re all in the accumulation phase and not about to retire.

Maybe where I differ is how I’ve been thinking of the emergency fund as that and only that. To pay for a new roof, etc. I haven’t thought of it as part of my portfolio. As a purely emergency fund, I still think it makes more sense (to me) to keep it invested and withdraw when emergencies arise. But maybe I need to start considering it as part of my portfolio, so I’ll assume we’re talking about that from now on.

That cash has probably cost me so much in lost gains over the last 10 years, as it was and still is a significant percentage of my net worth, but it's also given me the confidence to consistently save during that period including two market drops, so it's sort of a form of insurance: the price you pay to give you confidence to take a risk (and not sell out) knowing you're covered if the worst happens.

By save, I assume you mean save as cash? And in referring to the two market drops, you mean you saved instead of buying cheap indexes? I’m having trouble seeing how that is a good thing. The time I would most like to buy products is during a market drop. Wouldn’t it be better to save cash when the markets are roaring?

Like @adamu I find that emergency fund to be a great psychological boost to staying invested during downturns and keeping my asset allocations aggressive (meaning lots of equity index funds instead of bonds).

Again, why would you not stay invested during downturns? That is the best time to buy. They will rise. Isn’t using the cash to buy cheaply and dive in the best plan?

Something about seeing a large number in the bank just gives me so much peace of mind that an investment account doesn't.

Why? We assume markets will rise in the future as they always have, so if my index funds are down and I’m years from retirement, why would I need a confidence boost? I will be more inclined to buy as much as I can. That will give me confidence.

I don’t think of the cash as “doing nothing” because it’s part of that 20% that protects against market volatility.

Do you mean that since it’s not in the market it doesn’t lose value? Surely buying when things are cheap is a good thing.

I’ll likely start ramping up my “fixed” allocation to something more like 70/30 soon; I’ll be increasing the bonds and keeping the cash steady at 10%.

I know this is a different topic, but may I ask how many years you are from retirement? I’m currently 27% in SBI/iDeCo foreign stocks (All Country or equivalent), 10% J stock indexes, 9% foreign bond index and 54% in Apple stock. UK and J pensions later. I’ve been thinking maybe I should sell those Apples at some stage and move it to stock/bond indexes. I just don’t know when. I’m hopefully 8 years from retirement.

I feel like I’m fully invested and I’m not going to lose sleep over some slightly better gains I may or not see if some of my 10% cash were allocated into bonds.

But you aren’t completely invested. Your 10% is on the sidelines and isn’t going anywhere. Since you aren’t retired yet, how does keeping money out of investments that we can be pretty sure rise over the mid-long term be comforting?

In "retirement" I am definitely warming to the 'mountain of cash' / stock market investments barbell approach.

Feels enormously comforting.

In retirement it’s a different kettle of fish. I’m talking about when we’re still saving for that.

Again, thanks for your replies. I’m not saying any of you are wrong. I’m just looking for feedback.

[TokyoWart]

TokyoWart wrote: ↑Sun Mar 10, 2024 12:50 pm

Like @adamu I find that emergency fund to be a great psychological boost to staying invested during downturns and keeping my asset allocations aggressive (meaning lots of equity index funds instead of bonds).

Again, why would you not stay invested during downturns? That is the best time to buy. They will rise. Isn’t using the cash to buy cheaply and dive in the best plan?

Right, staying in the market during a downturn is the goal and the emergency fund helps to achieve it. If the market has a downturn and I suddenly lost my job or had an unexpected bill I would want to be able to use the emergency fund instead of being forced to sell stocks at a discount. I have personally experienced "emergencies" which required the sudden payment of over 10 million yen so this is not a theoretical risk for me. I don't think of an emergency fund as something to put into the market during a downturn because I don't think we ever recognize market highs or lows except in retrospect and I have never seen anyone consistently time the market successfully.

[Tsumitate Wrestler]

Emergency funds, buckets right?

1. 2000 yen under my phonecase
2. 20,000 yen in my wallet
3. 100,000 yen in my emergency bag
4. 6 months+ combined salary in the bank {12 months + living expenses]
5. 6 months+ in credit.

...........................

We don't do foreign bonds, due to the poor risk/reward. So we will hold more cash.

[adamu]

That cash has probably cost me so much in lost gains over the last 10 years, as it was and still is a significant percentage of my net worth, but it's also given me the confidence to consistently save during that period including two market drops, so it's sort of a form of insurance: the price you pay to give you confidence to take a risk (and not sell out) knowing you're covered if the worst happens.

By save, I assume you mean save as cash? And in referring to the two market drops, you mean you saved instead of buying cheap indexes? I’m having trouble seeing how that is a good thing. The time I would most like to buy products is during a market drop. Wouldn’t it be better to save cash when the markets are roaring?

No, I mean invest.

Something about seeing a large number in the bank just gives me so much peace of mind that an investment account doesn't.

Why? We assume markets will rise in the future as they always have, so if my index funds are down and I’m years from retirement, why would I need a confidence boost? I will be more inclined to buy as much as I can. That will give me confidence.

Usually when the markets are down, there is a reason for it and you will probably be very concerned with what's going on in the world, and not taking any money out of the stock market and putting *more* in seems like the least sensible thing to do, even though we say we would love to buy cheap in the good times.

Additionally as TokyoWart said, if the drop is significant and you find yourself forced to withdraw to cover expenses (because you lost your job, for example) you are forced to sell at the cheap prices if you don't have any cash alternatives.