By Dr. Jim Dahle, WCI FounderRegular readers know we dumped my disability insurance policies recently. We also dumped our emergency fund for a similar reason — we're rich.
An interesting thing about being rich is most rich people don't think they're rich. It's really weird how little insight some of them have. Sometimes they're incredibly out of touch with the people around them. But even those who know they are rich prefer other terms like “wealthy” or “comfortable” or “financially independent.” But it's all really the same, and acknowledging the facts as they are is helpful when trying to be logical about managing your finances and your life.
Purpose of an Emergency Fund
I've written before about emergency funds. The basic idea here is to have some money you can tap in an emergency that prevents you from
- Borrowing money,
- Selling investments at a loss, or
- Having to pay penalties or interest to raid retirement accounts
The classic teaching is an emergency fund is 3-6 months worth of living expenses in a very liquid, accessible, and safe investment. Sounds simple enough, right?
Opportunity Costs of an Emergency Fund
But the crazy thing about emergency funds is that the time you need it the most is when it is the hardest to get AND when your opportunity costs are highest (i.e. typically early in your journey toward financial independence.) At that point you're just learning to earn money, budget, spend less than you earn, and invest. You also have some great uses for cash, like paying off debt, saving up down payments, and maxing out emergency funds.
Due to opportunity costs, it actually took us YEARS to finally get our emergency fund where we wanted it to be. In fact, I think we were millionaires before we had a 6-month emergency fund. We just kept robbing it to make Roth IRA contributions or 529 contributions or 401(k) contributions or house down payments. Then we'd build it back up. Or we'd start spending more and so we'd need a larger emergency fund. At some point, we decided to go from a 3-month fund to a 6-month fund. It was basically a work in progress for a decade, rather than something we set aside early on and forgot about.
Retirees Don't Need Emergency Funds
However, just like with life and disability insurance, the closer you get to financial independence, the less you need an emergency fund. When you reach financial independence, you don't need it at all.
What? Is that crazy?
Well, imagine your favorite retiree. Let's say this person has $2 Million she's planning to live off of for the rest of her life. Does she need an emergency fund? No. She doesn't. She has a $2 Million emergency fund. Her entire nest egg functions as an emergency fund.
In fact, there are lots of things that financially independent docs don't need. Here is a partial list:
- Emergency fund
- Life insurance
- Disability insurance
- Debt/leverage/bankruptcy risk
- A job/boss
- ACLS, PALS, NRP, BLS, MOC, or an active license.
- Low deductibles
- Complicated portfolios
- Overly risky portfolios
- Financial worries
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Sorta depends on your definition of “emergency fund”. Are my T-bills an emergency fund? Or are they my “guaranteed investment”?
Money is fungible. If I needed money unexpectedly, I would pull it from the most logical place at the time it is needed.
I do what you do….keep some money immediately available, and am able to cover most “emergencies” from cash on hand.
Good post.
Jim, I’m glad you put these thoughts to a post, as I’ve also given this thought in recent months. I am not at FI, but my cash practice is similar to yours. My goal is 3 mo for E fund cash, and it gets “borrowed” at times when it makes sense as you alluded to. But also in this money mkt account exists many “sub-accounts” of money allocated for known larger/reoccurring yearly expenses. I’m familiar with the argument that keeping cash risks opportunity cost of investing money in stock fund. What I’ve done personally is consider the money market cash allocated for E fund as part of the fixed income/bond side of my retirement asset allocation (as eventually, as you wrote, this will all become part of overall assets come FI). This allows me to make the remainder of my retirement portfolio slightly more aggressive by keeping asset allocation in proportion with this cash included. Sort of my “middle of the road”, or “best of both worlds” approach.
What I got from this is that we are not the only ones who struggle not to rob our emergency fund for paying off debt, investing in a Roth IRA, etc. Glad to know it is something others do as well.
We would love to have 60k in emergency fund money, but usually sit closer to 30k. That said, we have other sources of cash we could use if we really had to have it.
In the mean time, we will keep looking forward to being financially independent (since we are still very early on that road) when we could ditch the emergency fund all together.
TPP
You do have an emergency fund. It’s the 30k you leave in your checking accounts.
So yeah that’s plenty since you have two jobs and passive income cause you’ll never be without income for potentially 6 months.
Fair point, except in a lot of ways that $30K is already spent. It was spent last month.
That is a smart move having your employees paid on contracts based on % revenue rather than a flat salary. Gives incentive to make the site more successful but also protects you on the downside.
I am not adamant about maintaining an emergency fund but I do have a low to mid 5 figure amount I like to keep on hand in my online savings account. I indeed sometimes raid it when an investing opportunity comes around but quickly build it back up to a level I like. For me mentally it is something that is a bit assuring. Sure it is a cash drag/opportunity cost but again if you won the game you don’t have to squeeze every single % point out there. Just knowing I have some cash on hand for whatever throws at me gives a peace of mind.
Last night I wanted to go in on an investment but scaled it back a little bit when I did the calculations and saw my savings account balance would be $7k. So I shaved a bit off the top of the investment pledge to leave my savings at a level I am comfortable with.
You also forgot to mention that you can use credit cards to bridge a very unexpected short term financial hit. I pay my cards off every month (2x/month actually to coincide with my paycheck and so that the typical balance is reported as $0 on credit reports) but worse case scenario if it does have a monthly balance and gets interest hit during a true emergency I could swing it and pay it off in the next month or so.
Relying on selling stocks in a taxable is a possiblity during a crisis but if you happen to have the crisis because the economy is tanking it could be a lose lose situation where you have to sell and lock in the losses. Therefore that is my least favorite method to cover.
Technically don’t have any employees besides the owners, but I agree it’s smart!
As far as selling stocks in taxable when the economy is tanking, that’s no big deal if you buy them in tax protected at the same time. In fact, if the stocks have a loss in taxable you should be selling them.
Most financial advise and terminology is made simple for those without any interest in it. Life isn’t simple and neither are finances and timing to pay for the unexpected. Technology and credit has made the urgency for cash in an emergency less stressful to the point where most people can’t even cover a surprise $500 event with cash. They list their credit card (or parents) as their emergency fund.
Like WCI, the financially savvy know where there money is coming from and what savings can be used for emergency status payments. This is a perspective of the organized. But saying that, too many surprise payments or combination of spontaneous purchases during a limited time can put stress on the financial peace of a household.
I like the emergency fund to be simple and it allows me to relax my financial mind when determining cash can be used quickly. It is convenient and I pay for it as an opportunity cost.
Again, it brings those who don’t constantly focus on their cash back to a relaxed, unstressed world of living moment to moment and knowing that a rainy day won’t be so bad.
I agree with your reasons for not needing an emergency fund since you have cash flow into you checking accounts to tap easily when in need. But I don’t get the opportunity cost part of having one. This is mainly for those who have high net worth but no cash flow. Say for example a physician has $3 M in net worth ( most of which is in investable assets which includes taxable and non taxable funds which they buy and hold), what is the opportunity cost of keeping 30k in emergency fund? That’s only 1% of their NW. how much is a constant 1% noninvested $ going to affect their NW?
that’s similar to someone richer like you and has $10M with 100k in cash (1% NW) which can be used either for emergency or invest when there is a lucrative opportunity.
Your argument makes a lot of sense. You can easily cover most needs with cash flow. I think that is more to do with your high income and low (relatively) spending. You always have cash coming in that you can earmark for whatever comes up. You unleveraged yourself allowing this to happen.
Someone could be “rich” and even have a good income but if their fixed costs are high then they do not have the ability to deal with these emergencies as well.
Example; income 240K a year= 20K per month, 15K after tax, 12K after tax deferred contributions, 11K after HSA/health/dental/insurance contributions.
In this example you only take home 11K a month. If your fixed costs come anywhere near there it is hard to come up with spare cash for emergencies. It is pretty easy to get fixed cost that high; mortgage 3K+ daycare 3K+ car payments 1K+ food/utilities/ etc can make up most of the rest.
I think this is another good example why being unleveraged is helpful. It may not make the most sense by the math but it opens up your cash flow and allows you more leeway to hold less cash as you described. This is why I do not have a car payment and hopefully some day do not have a mortgage. It will be nice when daycare goes away as well 🙂
Great post. Keep up the good work!
I agree with your lack of a need for an emergency fund given cash flow, etc. I am a bit less convinced with your arguments for dropping disability insurance and possibly term life insurance in your situation. Clearly the WCI “empire” is very valuable right now, but as the face of WCI what happens to that asset if you suddenly die or become disabled (such that you can no longer do any work-TBI, for example)? What is WCI without Jim Dahle? Since you can clearly afford to pay for insurance why not be covered for a worst case scenario for your young wife and children? Not to be a total pessimist, but the 4% rule might not work out so well starting in early 40’s with an incapacitated husband/father.
You might be surprised how much it is worth without me, but you’re right it’s worth less than with me.
We have a plan in place (a big push we made earlier this year), however, and it doesn’t require disability insurance.
Describe the “worst case scenario” (i.e. what it would take to actually compromise my family’s standard of living.) I have and it involves millions of Americans being wiped out by nuclear bombs. Pessimist doesn’t begin to describe what it would take. Selling this business for 1/10th of its value would likely provide for my family for the rest of their lives, completely ignoring the rest of our assets, life insurance, and ability to earn. They’ll be fine. Remember everything is already paid for. Cars, boat, house, educations etc.
i keep left over money in a separate Vanguard account I call “deferred consumption.” That is, money budgeted as available for consumption but not used and invested on a different risk level than the taxable, backdoor Roth, TSP accounts, etc. I try to keep checking accounts at the bare minimum. YMMV.
I agree That you don’t need one, and the average reader probably doesn’t need one when they hit FI, but the average retiree on a fixed income probably still needs one.
What do you mean a “fixed income”? You mean someone with no savings because they’re living on SS and a pension? I agree with that. But if you mean someone living on SS and a pension with a $1M IRA invested 50/50 in stocks and bonds, I disagree.
I’ve often wondered is there any reason that a Roth IRA can’t be used as an emergency fund? Typically, you will get better return than a standard savings account (even compared to the highest interest accounts) and the contributions can be withdrawn without penalty or taxes.
It’s also reassuring to know that we aren’t the only one robbing our emergency fund for higher-return investments or debt repayment. We don’t use the emergency fund for debt regularly but on occasion it has been more satisfying to knock out a high-interest student loan (6%+) and risk having only a 1 month emergency fund.
Especially with several years of training left. It’s very rare for residency/fellowship to close and release their trainees so job security is at the highest possible point in a career. Easy to live month-to-month with a paltry emergency fund when you have insanely high job security. Not advocating for living on a razors edge where a flat tire put you into credit card debt but 1-2 months seems like plenty for most people in training. The idea of a resident or fellow holding over 3 months of expenses in an emergency fund seems absurd, IMO.
Roth IRA isn’t the best in my opinion because you are limited to repay the account in the same calendar year. Roth IRA is always limited to contributions to the annual max so it would not be useful if you are currently contributing either by Roth IRA direct or by backdoor. Once the money is used for an emergency, you can’t necessarily put it back.
Agreed, definitely a downside. But if you had to choose between an e-fund and a Roth IRA and you might not need the e-fund, what’s the big deal about putting it in a Roth IRA (and investing it conservatively?)
I had an emergency fund as a resident and still have it now that I’ve reached FI and retired from medicine and I will still have it when I die. It just sits there for security. Yes my checking account has a large balance, but I know I can spend all of it if I want because the emergency fund will still be there. The emergency fund has a place, and because of it I know I can spend down the rest of the cash. I’ve never raided it to make an IRA deposit, because that is not an emergency. I waited until I had the money for the IRA and then did it. I never raided it to make the down payment on a house, because that is not an emergency. I waited until I saved the money for the down payment. My emergency fund is only for an emergency. It feels good to know it’s there.
Dr. Cory S. Fawcett
Prescription for Financial Success
I usually have a lot of cash too. It is more emotional than based on ROI.
Unpredictable things do happen and cash can solve a lot of problems fast. I have had doctor friends have their jobs eliminated unexpectedly (board certified ER, Fellowship trained pain doc, Harvard trained neurologist), etc. Two of the three scrambled to find another opportunity and settled for something less than ideal.
The third has taken a pause as a sabbatical. He is in a better financial situation. He works part-time and invests in real estate. He is now looking at a great job opportunity that came along when he wasn’t really looking.
Lastly, this is a gender stereotype but Dave Ramsey says having an emergency funds helps reduce the anxiety of some non-working spouses. That may be true. Although I’m not sure my wife cares much one way or the other.
I’ve heard him talk about that, mostly referring to his own wife. I know he does keep an e-fund.
I have 250K in emergency funds. 200K of it is just sitting around in some savings account giving 1.8%. This is roughly 7.8% of our net assets. I am really low in bonds, so I guess the cash and my house equity makes it a reasonable portfolio.
Our houses, boat and teslas are all paid off too. Zero debt. Boat and Cars are not included in net assets.
I think this is the first time I’ve read in a blog post the phrase “we’re rich.”
There are many FI bloggers out there who meet this criteria, but avoid saying this. It’s refreshing to read, and goes a long way towards breaking down the stigma associated with being wealthy.
We had a sizeable > 6 month emergency fund, but wiped out much of this with home construction. In retrospect, it was silly to have that much cash sitting in cash. We’re aiming to build it back up to a 3 month emergency fund.
— TDD
I totally agree and am amazed by how many bloggers, doctors etc are hesitant to admit this. It’s kind of fun on Twitter too when someone is disparaging “the rich” to take it personally and ask them what their problem with what you’ve done and have is! They’re DEFINITELY surprised to get pushback!
As earlier posts have said money is fungible and define what is an “emergency”. I prefer the concept of a “contingency” fund. Many near-term capital needs are not emergencies per se. Rather they have a variety availability and duration requirements.
Once you have a larger tax-advantaged portfolio you can keep a significant portion of your contingency funds in “virtual” manner in such accounts. It becomes part of your overall asset allocation.
Then when you have near-term capital needs, you can sell tax-efficient index funds in taxable and reallocate your portfolio. You have effectively not “sold” any equity positions in your asset allocation. This only works well when you are in a position where you are making periodic investments in taxable such that you can minimize capital gains if/when you have to sell for such purposes.
However, I worry even given the motivation and clear caveats in the post, that the wrong people will reduce/eliminate their “emergency funds”. It is the pre-attending and newly attending physicians who will most often be adverse to adequately funding an emergency fund. They are the very people who need it most.
We recently moved about two-thirds of our emergency fund into our investment portfolio. My job is secured via a long-term contract, and just about every other possible financial emergency we could encounter is covered by insurance. We just don’t need much liquidity. And our mortgage should be eliminated next year, and that will reduce our need for liquidity significantly.
My emergency fund has morphed into a cash position/contingency fund/sleep-well-at-night insurance/future project financing. I wrote an article for PoF when it was about $500k a couple years ago, and it has since nearly doubled.
I agree with you. And we are in a similar situation. But this is not really about an emergency fund but about getting set up for early retirement with concerns about sequence of returns risk and being in a situation where we have otherwise already “won the game” as William Bernstein would call it.
The first two paragraphs of this are gold. The fund is most needed when its hardest to set up. Im less than one year out of training and have so many other things id rather to do with my money. Using my HELOC as a fallback while I try to get things established.
The part about your taxable accounts is interesting too. They can be accessed whenever so why not just keep the money in there to begin with? If you never tap in to it then you have effectively just padded your retirement.
I still keep an emergency fund even though the dividend income from our taxable investment accounts would more than cover our living expenses and I’m reasonably securely employed. The concern I have is that emergencies still happen and can be very costly especially when you are “rich.” In my case, as an expat American living in Japan, there are significant tax uncertainties and I know if I suddenly had to repatriate I’d have an immediate $150K+ tax bill and that’s just the “known unknown” for me; no telling what emergencies I haven’t imagined yet. I also have checking account cushions (around $10K each in three accounts), the funds we are using to “cash flow” a son’s college tuition, and the quarterly tax payment account but if the emergency happens I’ll still need those funds for the things they are intended. I’m on the extreme end of risk-taking on investments (all equities, no bonds, no market timing) and that’s also colored my thinking on the need to maintain the emergency fund well beyond a point of financial independence.
I said yes emergency fund… We keep minimum 4 figures (one month’s expenses only) to 5 during some months in checking account just because my math is imperfect. We have a lot of fixed income- pension, my job now- and I project future expenses like estimated taxes or potential college bill or the porch rebuild and if we’ll have enough by when it’s due or not and build up the cash if need be, sometimes plunking it into a 3 mo CD for a few extra pennies.
But my real emergency fund is a CD ladder (I’m too lazy to muck with bonds, but have actually punished USAA by moving CDs to the local CU with higher rates when I can) which I try to keep kicking over enough to cover a wedding or two with only 3-6 months notice (they have a pretty small wedding budget). It is for any other ’emergency’ like if we wrecked a car or had 8 plane tickets one month instead of our average one. My slightly manic squeezing another higher rate 5 year CD out of the budget when that could possibly run us into a spot of short fall would be covered, if need be, by closing a CD early and paying the penalty. Ain’t I lucky? I get a small rush from opening another 5 year CD instead of buying a Tesla or a few new pairs of Ferragamos.
I count the CDs as part of my nonstock investment (and so keep little to no bonds other than G fund in TSP), and try to ensure I keep the ladder solvent. If it dried up that would mean a major rethink of our retirement spending strategy. But I have to acknowledge it is my de facto emergency fund despite not technically needing one. Would just hate to have to sell stocks or bonds when we hadn’t planned to, and the turn around of possibly a week is more than I am comfortable with if I have a sudden expense- I want a phone call or computer click with the bank to properly stock my checking account in the moment.
We had one year’s expenses in an e-fund about a year ago. The change for us occurred when we went from a mindset of scarcity to abundance (philosophical sounding, but quite influential). Opportunity cost was a factor, but not as much at first. We are young and definitely not financially independent yet, but we are on the right track. Once we truly grasped the fact that the insurances we carry (and credit) would cover costs during a major emergency, it was much easier to “let go” of most of the e-fund and build up our taxable account. We have extremely secure jobs for the time being, and keep 2 months cash on hand.
If you have $2M set aside for your retirement and that portfolio’s income is adequate to cover your household spending, then taking an extra $10,000 or $15,000 to cover an emergency would harm the portfolio’s ability to generate that same income. That’s the way I understand the math and so an emergency fund still seems necessary.
This exact thing happened to me when I retired in 2016 and had to spend a ton of money on a medical board investigation. I didn’t have enough set aside in my EF and so had to put it on a credit card which sort of sucked. It is a touch painful to have $20k sitting around collecting dust but unless I learn otherwise, it seems appropriate. Great topic though.
So how do you plan to replenish said emergency fund after you spend it? By spending less than your withdrawal rate and putting the difference into your emergency fund? Seems awfully conservative.
DW and I are early retired. We don’t keep an emergency fund per se, but we have a sizable amount of money (still a relatively smaller % of our financial assets) in a combination of short-term treasuries, a premium MMF, an online savings account and recently added CD’s. We consider these more like the short end of our Fixed Income allocation. However, they also function as ready cash should we need it for some unexpected expenses (e.g., we recently discovered that we need to replace the septic field in our home this month at a cost of nearly $25,000). No worries with ready access to cash.
Truth be told, if there were better Fixed Income options (i.e., decent yielding muni bonds) a good deal of this cash would be invested there. However, the market for muni’s has been severely overbought for the last 9-12 months. As a result, we can get better yield where this money is sitting now (where it is currently earning at least 2.5%+) taking zero credit and little term risk. Until that changes, we think it’s best to leave things as they are.
How much does a typical muni bond fund pay? The California Intermediate and long term Vanguard funds yield 2.6 and 3.3% (investor shares, VCAIX and VCLAX), respectively, and serve as a decent emergency “fund” although they can lose value. Pretty good for tax-free but principal can go down. Maybe I’m missing something…
Rouge One,
It depends of course on the duration of the bond(s) as well as the credit rating.
Be aware that the yields you are quoting are historical and not current. The current 30-day yield (as of June 3rd) on VCAIX is 1.69% and on VCLAX is 2.14%. Also, VCAIX has a 5 year duration while VCLAX is 6.6 year. So a fair bit of term risk. For comparison, a year ago I was able to purchase high quality muni’s of this approximate duration with tax free yields close to 3.0%. So 1.69% or even 2.14% is hard to get worked up about. If I had to choose between the two I’d likely lean toward VCLAX (higher yield for not a ton of added term risk).
FWIW, last week I bought a 15-month CD at Ally bank with a yield of 2.80%. For VCAIX to offer a comparable yield your effective margin combined marginal tax rate would need to exceed 40%. For VCLAX it would need to exceed 24%. However, the average duration of these funds is multiples of 15-months. So not really apples to apples and not overly compelling for the two funds IMHO.
Be careful about what Allan Roth calls the muni bond illusion.
https://blogs.wsj.com/totalreturn/2013/04/04/beware-the-muni-bond-illusion/
WCI, I Agree. However, this is a bond fund. Isn’t Mr. Roth discussing a single bond coupon?
MikeG, CA rate is 8-10% for most physicians on top of a 24% federal rate. So the VCAIX or VCLAX should save a CA resident 32% minimum. Bond fund yield has to be only 1.9% to the 2.8% for the non-muni bond fund.
Also, I’ve ignored appreciation or depreciation of the fund as I’m holding it long term. MikeG, did you buy the individual bond at 3% yield or a different fund? Thanks
Rogue One,
I purchased several muni’s back in 2017/8 with YTC’s (approximately 5-7 years out) around this level (all were AAA or AA rated bonds). I own about three dozen individual muni’s purchased over a long period of time – one by one in the secondary market. I have a bond broker who sources these for me.
Having said this, he has not reached out to me with a single opportunity since the summer of 2018. I check in periodically and he has so far agreed that based upon the current (or at the time of discussion) state of the muni market, I’m probably better off buying short-term Treasuries. I’ve accumulated a large holding of Treasuries waiting for better opportunities in the muni market.
My living expenses are only $1500 a month. I have no problem leaving $4500 in an emergency fund. But I agree, the “3-6 months” part of the emergency fund formula doesn’t make much sense. It’s great for teaching discipline in the beginning and showing yourself that you’re capable of saving. But I think anything over $10k is unnecessary
I don’t have an emergency fund. If there were truly an emergency, I could use credit cards, which I have at least 4 weeks to pay off. Meanwhile, that’s enough time to get a bank loan.
Also, it’s my opinion that you still have an emergency fund. You said you keep $30,000 in bank accounts. That’s an emergency fund.
Many view the point of an emergency fund as being able to avoid debt in an emergency. If that’s your view of an emergency fund, then a credit card, maybe the worst debt, isn’t a very good option. And the same emergencies that make you need money (getting laid off) also make it hard to obtain credit.