By Dr. Peter Kim of Passive Income MD, WCI Network Partner
Before we get started, I wanted to include a small disclaimer: every situation is different, and what works for me may not work for everyone. I’ve crunched the numbers and found that an emergency fund isn't best for me. Will it be the same for you? That's what you'll have to decide for yourself. With that in mind, let's dive in.
What Exactly Is an Emergency Fund?
As you probably know, an emergency fund is meant to be a buffer for unexpected costs or bumps in the highway of life. These might include the following (all are things I’ve experienced):
- Unexpected healthcare costs: Like an ER visit for broken bones or suspected appendicitis
- Car issues: blown tire, broken windshield, etc.
- Unexpected house issues: roof leak, broken pipes, and subsequent flooding
- Unexpected pet costs: my dog inhaled a foxtail, and it required a $1,200 procedure to remove it
- Job loss: I actually haven't experienced this, but I know it's a reality for many people
Given how devastating unexpected events like these can be to the unsuspecting family, most financial experts (like Dave Ramsey) recommend that your emergency fund should be able to cover 3-6 months of full expenses. Exactly how many months depends on the stability of your job, whether you have dual incomes, and how healthy you are. Suze Orman even advocates for eight months of full expenses.
Now, I’ve read Dave Ramsey’s Total Money Makeover. In fact, I recommend that most people should read it. Having read it when I initially finished my training, I built up a sizable emergency fund, and I was confident in my ability to weather any storm.
Then . . . I watched as that cash sat there and did nothing. All I could think about was how it was wasting all of its potential.
I began asking myself whether having an emergency fund was truly the right thing for me. I decided to do a deeper analysis, and spoiler alert, I decided against the emergency fund altogether.
More information here:
Are Emergency Funds for The Weak Minded?
Why I Feel I Don't Need an Emergency Fund
Here are the considerations that went into my decision:
- We are a dual-income family: I work a little less than full-time. My wife is a doctor, and although she only works part-time now, I know that in a pinch we could both work more.
- Delayed payment from work: In terms of billing, I am paid on a two-month lag. For example, on March 1, I get paid for what I did in all of January. There is almost always a lag between service, billing, and collection. So I know that if something comes up, I'll still have a paycheck coming in for the work I've already done.
- Disability insurance: Not only does it cover 30% of my current income tax-free, but I've also added a partial disability rider. If I experience a drop in income of more than 15% due to a disability or injury, after a period of 90 days, my insurance company will start paying me to compensate for the difference.
- Passive income: Of course, this is a big one for me. I’m earning passive income from other sources, which currently covers over half of my expenses.
- Home equity line of credit: I opened up a HELOC that is maintained for only $75 per year. If I had to use it in a pinch, this could cover 10-12 months of expenses.
- I’m decently adept at selling things online: If it really came down to it, I could sell some of my possessions through eBay, Craigslist, and FB. I’d start with some of my wife’s nice purses (shhh, don’t tell her).
- Opportunity cost: This is a big one. Sure, I could have funds in a high-yield savings account like Ally, but with an average yearly inflation rate of 3%, a 1% return simply isn’t enough. I wanted to put that money to work.
More information here:
What I Used That Money for Instead
So what happened to that sizeable emergency fund of mine? I chose to invest it, and so it went to (and continues to go to) crowdfunding, investment properties, and taxable accounts, to name a few.
When an unexpected event does occur, like that $1,200 procedure when my dog inadvertently sniffed something up his nose (which has happened twice, by the way), I put it on my credit card. By the next month, I’m able to pay it off in full as my paycheck comes in. I’m fortunate enough to have a buffer and don't live paycheck to paycheck, and I always pay off my credit card in full every month. If the worst-case scenario occurs and the expense is very large, I could tap into one of the resources mentioned above, like my HELOC.
Ultimately, this is just one situation where I decided that the conventional wisdom just wasn’t right for my particular situation. Obviously, I believe that you need to be prepared to handle life’s unexpected circumstances. After all, the one thing we can count on is that life is unpredictable.
I say, make sure you’re prepared for an emergency, but do it in a way that makes sense.
Has anyone else eliminated their emergency fund? Does anyone think I’m not being smart about this? Comment below!
Do all of the crowdfunding and on line real estate funds do well and pay off? I have never done one.
Thanks
All of them? No. Some outperform the pro-forma, some underperform it. It’s even possible to lose money. It’s even possible to lose it all (as I have in one syndication.) That becomes less likely the more you diversify of course.
We don’t have one either. HELOC and credit cards cover most emergencies. We save for quarterly taxes, so that cash could be used as well. I also created a cheat sheet (mostly for my husband since I handle finances). If something were to happen to me, it shows where we should pull cash from first or where he should cut back if needed (example stop maxing out 401k).
Be careful with the HELOC as a back up cash source- issue is when you need it most (macro economic problems – deep recessions) is when the bank can end the Heloc or cut the capacity and demand payment over a set period of time
This happened in 2020 and also during the GFC
Aside from the fact that many of us view the point of an emergency fund as allowing us to not take on debt in an emergency.
Hmmm.
This one will be very individual depending on age, years to retirement, income sources, health status, and other factors. Having sold the “big expensive house”, downsized markedly and dropped down to two days a week, our emergency fund is bigger than ever before.
It covers two years of expenses. I only planned to work part time for two years, so, in two years I have to start selling investments to pay our bills.
At present, my portfolio is notably down in 2022 with no signs of a reversal and little economic projection data to suggest that 2023 will be any better. I’m starting to like the “cash is king” articles.
Some financial statistics are at their worst levels in decades or even half centuries…
You can invest “emergency funds” in short term notes, supply chain financing, short term treasuries, real estate platforms (with quarterly liquidity), and high yield savings.
For me, I like having a large emergency fund. I don’t want to go back to “working more”. In fact, I will be quite happy to not work at all. But, I don’t like the “worst since the 1930’s…” and “worst bond market since…” data with an ongoing and escalating war in Europe.
What if this is the 2008 of the “2008-2013 financial debacle”? Stocks could drop “another 40%.” That would take a while to “come back”. I’m holding on to some cash. Two years worth at a yield of > 4%. I have plenty in the equities bucket and almost nothing in the bond bucket (since about 5/2020).
I know…plan, allocate, and forget…but really, isn’t there anything a bit unique about the current situation? For the almost retired, caution is prudent.
Huckleberry I’m in your shoes. Trying to continue ignoring the market as I have for 3-6 decades, and happened to pick a bad year to pay off my mortgage from our long term emergency fund- a CD ladder- and now have a lot of gaps in that ladder I am unwilling to start to fill by selling stocks soon as was the plan. Instead want to finish my Roth conversions which of course increases expenses with that tax bill.
Pretty sure I will outlive this contraction but a little anxious; luckily that emergency fund is supplemented by our pensions and the remaining CD ladder and rarely truly needed.
As an interesting side note, my 30 yo daughter said “Well Mom, you and Dad are my emergency fund.” If called upon to live up to that, she can pay our taxes/ losses!
This article clearly does not represent the economy today. One can buy off the secondary market short term CDs (through most brokerage firms), short term corporate bonds (best is IBKR but any brokerage), or short term treasuries. I have built a ladder for the next 18 months. If needed in emergency I would allow to mature and receive cash; otherwise I reinvest and keep the ladder ongoing. My average return is 7% on the ladder. Cash is no longer trash.
Good plan for those still investing from their paychecks, but for us retirees the issue is moving money from longterm stock type investments to cash/ bond type more accessible accounts. Just seems like if we can wait a few months or a year, we should. Will ignore that feeling and make myself do some stock sales on schedule in the coming year even if market is still Bearish.
What don’t you buy $20k ibonds every year? In 1 year that’s your emergency fund (12 month waiting period before withdrawal) and if not needed you can keep 30 years and use as the fixed income portion of your portfolio.
I think it’s a good idea to challenge those “bedrock” financial rules from time to time, if even just to make yourself feel more confident in sticking to them. For instance, why should any young person hold bonds in their retirement account? They shouldn’t, it’s a waste. You can’t touch that money for decades anyways, might as well try to max out your gains with equities for as long as possible.
In regards to an emergency fund, this is one of those financial rules I feel more uncomfortable breaking. Life is unpredictable. It doesn’t take a great imagination to come up with any series of events that could really stress you financially. And while disability insurance and having home equity that you can tap can certainly be apart of your emergency cash plan, nothing beats having liquid cash available in the event of an emergency for the short term. Maybe you don’t need 3-6 months of full expenses in cash if you have other options you can use in an emergency, but I sleep a little better at night knowing I have liquid assets if needed. And with rising interest rates, savers have better options everyday. It’s not hard to find a high yield savings accounts or money market fund yielding close to 3%, or a short term treasury fund yielding 4-4.5%.
For high income earners with significant assets, keeping 3-6 months of cash on hand may indeed be a significant unnecessary drag on potential returns over the long term. But for your median income worker, having 3-6 months of cash is probably a pretty important goal to strive for.
But ultimately I think you are correct in that everyone needs to critically evaluate just how much cash they really need to keep on hand at any time. I imaging many high income earners will find they don’t need quite as much as they thought.
I think you’re entirely too black and white about bonds. Here are the counterpoints to your arguments:
https://www.whitecoatinvestor.com/why-bother-with-bonds-a-review/
https://www.whitecoatinvestor.com/100-stock-portfolio/
And for emergency funds:
https://www.whitecoatinvestor.com/are-emergency-funds-for-the-weak-minded/
If the point of your emergency fund is to avoid taking on debt, then how does debt serve the purpose of your emergency fund?
I think the value of the emergency fund depends greatly on your financial stability, assets, income, and risk tolerance. If you have a relatively large portfolio +/- strong passive cash flow, your need for an emergency fund is greatly diminished.
If you have a ton of fixed expenses, eg massive student loans and mortgage, you really could benefit from a sturdier foundation. Eg a new resident.
It seems pretty easy to argue that a low leverage, high net worth individual with a ton of passive income doesn’t need to sit on a mountain of cash. On the other hand, it’s hard to argue that there’s such a huge opportunity cost to holding some cash when you’ve “won the game”. It may just be a matter of preference at that point.
Lastly, if you’re always saving up money for larger deals, eg direct real estate investments, it’s likely you’ll need to have some cash on hand and make decisions about when you’ll put that money to work and when you want to hold cash for stability/better opportunities. That’s a very different situation than an early career professional trying to get their financial house in order.
Reminds me of someone explaining why they don’t need seat belts. I mean there are air bags, automatic braking, and lane centering. Sure, all true, but I’ll still put mine on.
I think the article is well reasoned out. As long as you have access to a liquid resource that can be quickly tapped, you should be fine. I max out I bonds every year and plan to tap that in a true emergency. There is enough of a buffer from paychecks that I can just invest less in taxable during periods where I have unexpected costs. I consider things like replacing the car or a house repair an expected cost and set aside an amount every month for this in a High yield savings account.
I like the idea of a HELOC for an emergency fund along with having a collateral loan set up using stocks. The problem with both is with the rising interest rates the bank is increasing the rates on the loans if you need to use them. Not the good deal it use to be. My thinking now is I rather have the money ready if needed in an emergency fund earning nothing then use a 6+% line of credit.
A lot of moving parts, which when you retire what you have is what you have.
Love the post and the articles.
I think everyone’s situation is different. I have a lot of mental health issues and an auto immune disease . Some of the drugs I take are not covered by insurance. I’m also self employed and don’t make the same amount month to month .
Due to so much uncertainty, several years ago , I sold my house and bought a condo cash . I have probably 4 years of emergency funds saved up , just because of feeling insecure with my health , being self employed and the economy. I’m also single , so should things go south , I’m on my own .
Do I wish I could invest my 4 years of emergency savings just sitting making 2percent ? Yep . But just don’t have the confidence in the market
I don’t have an emergency fund either.
My cushions:
1) A 50K HELOC (for large emergencies>10k)
2) Credit cards (for emergencies <5K)
3) Passive income (which can cover the <5K emergencies most of the time)
4) I'm still employed full time, so have health, disability and term insurance). I also have personal Umbrella insurance
5) I work for the state, so I consider my job to be fairly stable
I hope my thinking is solid. I invest what would have been in my emergency fund.
The ideal time in a person’s life to avoid a large cash emergency fund is in the early years when one has a low net worth & that cash has 30+ potential years to grow. This is unfortunately also the time when an emergency fund is the most useful.
When you’ve already amassed a 7 figure net worth mid career and can easily go without an EF if you have a substantial taxable account, having a small percentage of your net worth in cash will make no significant difference in the final outcome.
When you need it most, the EF is most detrimental. When you don’t need it anymore, having one won’t hurt you.
You’ve identified the dilemma!
Best emergency fund is your invested HSA. Pay medical expenses out of pocket and keep the receipts and a running tally of how much the HSA “owes you.” There is no rule on when you have to take the money. You just have to prove it was for a qualified medical expense.
Your HSA stays invested unless you REALLY need it and of course contributions and earnings are tax free.
Another option that I subscribe to is the margin loan.
If you have a large enough taxable account it can be much easier to simply take out your emergency cash from a Margin Loan as needed. Less paperwork, superfast, almost always better interest rates, no drama.
When I started this plan, I had an emergency fund, and for opportunity costs reasons I reached the same conclusion as the author. Why not have the size of my emergency fund grow, infinitely, and maintain access to its value as needed. So I shifted all of my emergency funds to my brokerage account.
For instance, I have used margin loans to start a business and bought a car, I know of multiple people who have bought houses using this method. One gentlemen could not get a mortgage on a house, because this particular country would not give a mortgage to non-citizens, problem solved.
Where can you do this?: Any major brokerage but IBKR and M1 tend to offer the best rate, well under a HELOC rate.
The exact rate varies as the FED rate varies, but it also depends on which type of account you have (PRO or LITE with IBKR) and how large your account is. Currently 3.58 to 5.58% , however a year a year ago it was like 1-3%, again following the FED. ETRADE rates are horrible, alot of the other Major Players are also too high to be viable with this plan.
PROS:
Fast: Last time I did this I had access to 50k in a matter of minutes, transferred to my bank account.
No application: As long as you ask for it when you set up your account, there is no separate loan application.
Credit Reporting: Not on your Credit Report
No annual fee to maintain vice a heloc
You don’t have to own a home to do it.
CONs:
1. Now the obvious risk is the margin call….what if the market crashes and I’m over drawn and they start selling off my assets. This is a real possibility, MAR 2020. Quite frankly my response would be…..don’t draw that much money. Also similar to Banks changing HELOC rules, the amount you need for securing a margin loan can change rapidly, this occurred in AUG 2020 I believe, there was a one month notice, but it was real. Currently IBKR needs at least 25% security to not margin call you.
2. The rates can adjust, following the FED, which could get better as well.
3. Obviously if you want to have access to a large “emergency fund”, you will need to have a much larger taxable account.
I can’t speak to everyone’s level of comfort, but as long as you don’t overdraw, it’s the best deal in town.
I myself would never draw over 25% of my total value. So if on 1JAN2020 my taxable account was worth 100k, and I borrowed 25K to go by a new Camry at 1.5%apr (at the time)….as long as my account’s value stayed above at least $6,250 (25% of 25k), I would not be hit with a margin call (per current IBKR rules).
So in my scenario, the market would have to crash94% ish in order for this method to tank.
So one could be a little risker and borrow higher than that, but that’s my level of comfort, based on the idea, that the market would have to crash 94% for this to fail, and if it does, I will likely have bigger problems.
Hope this helps someone, I’m also curious for any feedback you have, but don’t worry about me, all loans are currently paid off.
I agree with your reasoning. Whether you use the taxable account to borrow against or to sell, people with a huge taxable account, like retirees, don’t need an emergency fund.