Our emergency fund is exactly $0.00

In our financial plan, you will never find the one staple item that every so-called financial planner calls the cornerstone of a responsible financial plan: the emergency fund. We have none. Zilch. Nada. 

With the exception of about $100, maybe $200 in small bills in a safe place in our home, and about $1,000 in cash in our checking account we have zero cash sitting around. Not that we are so cash-strapped that we couldn’t afford an emergency fund. Our net worth is solidly in the seven figures and north of 30-35 times our projected retirement spending budget. We never had an emergency fund and never plan to have one. That doesn’t mean that we never have unexpected spending shocks. If we do need cash we will get it from our vast supply of “emergency cash,” which is, in exactly that order:

  1. Credit card float (=interest free loan from the credit card company between the transaction and the credit card payment due date)
  2. Papa ERN’s paychecks
  3. The $100,000 HELOC (home equity line of credit) on our condo
  4. Finally, a large sum in several brokerage accounts, more than half our liquid asset net worth

If the so-called financial planner guild didn’t already have high blood pressure before, they probably keeled over with a cardiac arrest just about now when they see that we use a line of credit as our emergency fund. Let me explain where we come from:

The main reason against having an emergency fund: Opportunity Cost

The concept of opportunity cost is as old as economics itself. In fact, I still remember my first economics class in college. Econ 101 (or whatever the number was at that time), first lecture, first few minutes of the lecture after the intro, the professor explained the most basic concept in economics that everyone has to understand: opportunity cost. It seems that the bozos in the back of the classroom who later failed that final all became financial planners because this whole emergency fund business is one big hogwash and completely irrational from an economic/financial point of view. Don’t believe that cash holdings are a large, unnecessary cash drag? Check out this blog post on Personal Capital: In the last 30 years a 70% Stock, 30% Bond 0% Cash portfolio grew from $1.00 to $18.36 (nominal). A 60% Stock, 20% Bond, 20% Cash portfolio grew to only $14.11, almost a quarter less. That’s a steep price to pay for the luxury of having cash sitting around.

Back in the old days, financial planners recommended 3 months of expenditures, but that was when money market accounts actually paid interest. Suze Orman now recommends having 8 months worth of cash earning 0.50% interest per year (before taxes). By the time we need that emergency cash, an equity portfolio would have already doubled to 16 months of expenses. So, if you have substantial amounts of savings, who needs an emergency fund?

Another example that shows the total utter irrationality of the so-called financial adviser community is the recommendation to start an emergency fund even before paying your credit card debt (here and here and here), which is the pinnacle of financial illiteracy. The “logic” is that, and I quote from the last of three sources above: “having an emergency fund in place is going to keep you from taking on more debt when an emergency hits.” An analogy of this idiocy would be this: a fire truck arrives at a burning house. The truck carries enough water to extinguish this fire. But instead of fighting the burning fire (the equivalent of 15% interest eating your future) the truck waits for a second fire truck to show up (saving in the emergency fund) for fear of running out of water, just in case there is a second fire somewhere else in the neighborhood. How dumb is that?

But what if something does go wrong and we need cash?

  • If we can pay the bill by credit card we pick the card that currently offers the longest float, that is, the card that will give us the longest interest-free loan. By the time the credit card bill is due, we have likely gotten income to pay the credit card bill. If the bill was still too large we pay it from the HELOC and then use future paychecks to pay down the HELOC. True we might pay a few dollars in HELOC mortgage interest but that cost is only very occasional and still significantly smaller than the opportunity cost of tens of thousands of dollars lying around at essentially zero percent interest.
  • So far we never even needed to go to step 4 as described above, i.e., sell investments to cover costs. But if we have to we will. We made very good money with our investments, thanks in part to never falling for Suze Orman’s emergency fund fallacy. We might as well spend some of that money in an emergency. Or better: The money that we didn’t hold as cash but invested in equities has already grown so much over the decades we can use the dividends from that account to pay the bill!
  • Our health insurance has a manageable annual out of pocket maximum. Large medical bills we got in the past were always small enough to cover with our regular paycheck. What’s more, we normally receive the bills with huge delays, usually 3 months after the services were rendered, thanks to our hopelessly bureaucratic health care system, so we have ample time to prepare. After receiving the bill we again have probably at least a few months to delay the payment and then we use, you guessed it, the credit card with the longest float. By the time the credit card bill is due we had probably at least six months of time to prepare for that “emergency” expense.
  • If Papa ERN were to lose his job, we currently have enough net worth to completely retire. Besides, his employer would be contractually required to pay a pretty substantial severance package (unless Papa ERN does something really, really reckless and stupid and gets himself fired with cause), including large sums of deferred bonuses that would definitely sweeten the transition. Health coverage would also continue under COBRA, though we’d have to pay for it.
  • Papa ERN has a very generous package at work that covers long-term disability. His company would pay 70% of his salary if he were to become permanently disabled
  • Papa and Mama ERN have life insurance, just in case
  • Other emergencies, like car repairs or appliances breaking down, are so small relative to the monthly paychecks rolling in that we don’t really worry about them. We live in a condo where big-ticket repairs are covered by the homeowners association fees. There is not a single item inside our home that couldn’t be replaced for less than $1,000. Why do we need 8 months worth of salary sitting around idle for that?

A behavioral reason

Money that’s just lying around looks very tempting. Before you know it that emergency fund might be used to buy an “emergency flat screen TV” or an “emergency vacation.” We think frugality is a lot easier if you are not literally but effectively cash-strapped like we are, and before you buy any big ticket item you have to weigh the actual cost.

An emergency fund is easily raided for all sorts of wasteful spending. Especially since the current interest rate is so low, it would be all too tempting to get a 0.50% interest “loan” from your emergency fund, for that shiny new thing waving at you; a boat, a down-payment for a new car, you name it. On the other hand, it’s a lot harder for us to sell our investments or dedicate future investments from bonus payments and paychecks for some wasteful spending.

Funny Accounting

If the reasons above weren’t enough, the entire idea of an emergency fund has one additional fatal flaw. If you are really serious about your emergency fund, right after spending on an emergency event you’d have to replenish that fund back to 8 months of expenses, right? Unless you believe there will be only one single emergency in your entire life. So right after that first big emergency, you’ll soon have to start scrambling to save to replenish your emergency fund. Just like we scramble to pay down our HELOC with future paychecks. The cash flow strain for us is the same as or at least similar to people with an emergency fund. The only difference is that we never had the drain of opportunity cost because we invested our life savings in high return assets, not in a 0.50% money market account.

Update: Make sure you also, check out our follow-up posts here:

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126 thoughts on “Our emergency fund is exactly $0.00

  1. I agree, but with a couple small caveats:

    1) I believe a small emergency fund is prudent if you don’t have assets because you are a very high risk if something happens to your income. I have heard of people being cut off from their credit accounts, usually because of something like missing a payment after a job loss but there are plenty of honest mistakes that can make creditors look at your current situation and suddenly end your credit lines.

    2) There is an assumption that you have a reasonable amount of your assets in liquid investments. Lack of an emergency fund might not work for someone too exposed in non-liquid investments.

    As my portfolio has increased my comfort with a smaller emergency account has increased as well for the very reasons you outline. As long as you have something of value you can liquidate and have defined “emergency” appropriately you should make out much better with the investment than the cash.

    Liked by 1 person

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  3. Great post! I drafted a post for my blog about how I increased the return on my cash savings when I realized that it seemed the opportunity cost was very high for havings a significant amount of cash on hand. I started to do some research in the personal finance community and came across this post. I’m not moving my cash position into investments today, but I’m thinking about it based on your post and a few others. I hope you don’t mind that I linked to this post on my blog and I’m sending my readers this way to read more about your alternative to a large cash emergency fund.

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  4. I agree with using your credit card float and HELOC but I also believe in holding cash for: emergencies (several thousand $ in bills, recall the cash shortage and ATM problems in Puerto Rico this past hurricane season!) and for bargain shopping when stocks sell off as they did earlier this month. I wrote about the merits of holding cash just a couple of hours ago:
    https://firechecklist.net/2018/02/25/cash-as-an-asset-class/

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  5. The emergency fund is supposed to be for when you lose your job. In a financial crisis like 2008-9 the bank might stop you borrowing against your house as well and your stocks have halved in value. Also companies tend to cut dividends in financial crises… Historically, I didn’t really have an emergency fund though too. Much of the time I had little chance of being fired as an academic and have the life and disability insurance. Right now I do have a pile of cash, but it is effectively reducing my mortgage in what is called here an offset account. Longer term I would rely on investments that are negatively correlated with the stock market as the emergency fund.

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  6. Isn’t the whole emergency fund talk a bit of a misnomer?

    Dave Ramsey and others use the emergency fund discussion to really focus on people who don’t have substantial assets. There, the emergency fund is an alternative to debt and their target audience is typically struggling to know how to properly manage debt, so creating a safer alternative is of real value.

    The FIRE community by definition are people who have (or strive to soon have) substantial assets. Most of the things I hear people describe as emergencies are not emergencies to someone that has substantial assets. They are unplanned expenses. And in that respect I wholeheartedly agree that the “emergency fund” mantra seems silly if what you are talking about is an unplanned set of tires, etc. For the FIRE community, I would think the biggest emergency risk is job loss in a down economy before hitting your FIRE number, particularly among high-income professionals who may be making a lot today and aiming for and living a lifestyle that’d require fatFIRE, but nonetheless could find themselves struggling to replace that income with a comparable job if forced onto the labor market unexpectedly. Essentially, it’s a version of sequence of returns risk, is it not?

    To me, instead of talking about emergency funds, isn’t the real debate here is what’s the optimal amount of one’s portfolio to hold in cash/cash equivalents? I think few plan to live in a just-in-time world of selling stock each time they want to engage in an act of consumption during their retirement. The question in my mind then is what’s the optimal amount of cash to hold for what time and for what reasons? People will clearly move into cash the amount of their planned expenses within some window around the actual date those planned expenses are incurred. The question would seem to me to be: (1) how much in front of the actual date of incurring the planned expense would you move the funds into cash, (2) how much of a cushion, if any, would you create around your forecast of those planned expenses? Also, I presume the main complaint about emergency funds is the delta between returns on those options and the stock market. But there are way better options these days than a .5% money market. A simple online savings account will get you 1.4-1.65% these days without breaking a sweat. Some short term CD options already are back up at or over 2%. Is there a spread between the emergency fund options and a higher stock market return where you would be willing to trade some potential return for greater safety?

    For me I have a large amount of my portfolio (16%) sitting in cash equivalents, earning around 1.7%. I will readily admit that this is driven by emotion and not optimization for me, having lived once before through a job loss, my portfolios tanking and being upside down on a mortgage simultaneously. (Today, at least I’d have a bigger stockpile if I faced the same situation.) I also expect that cash percentage to shrink substantially going forward. By the time I hit my FIRE goals, that percentage should be down to less than 7%. It will probably be down to 12% in the next 2-3 years.

    Liked by 1 person

    • Very nice summary. Almost a guest post! 🙂
      Maybe we should simply ask Ramsey and Orman if they would still recommend the EF for us in the FI community! My suspicion is that they would. They seem to be pretty inflexible in their beliefs.

      Good point about the cash portion in the portfolio. I also like to look at the overall portfolio and not by bucket. If someone close to retirement doesn’t want to deal with 20% implied equity volatility and duration risk for long-term bonds, then absolutely, hold some cash to de-risk! I just don’t think that someone who’s 25 years old is just starting to invest needs to de-risk.

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