The Emergency Fund: It’s Still Useless!

May 26, 2021

One of my earliest blog posts back in 2016 detailed my thought process for skipping the emergency fund. Back then, while we were still accumulating and saving for early retirement, our entire seven-figure equity index fund portfolio served as our emergency fund. We never kept more than $1,000, maybe $2,000 in a checking account. We’d simply used the credit card float and/or the Home Equity Line of Credit (HELOC) if any larger expenses came up that exceeded my monthly cash flow, e.g., car and home repairs, medical bills, etc.

So, again, the idea is that if you are a practitioner of the FIRE movement and you save and invest aggressively just put all your money in an equity index fund and be done. It’s not crazy at all to simply invest your emergency fund in stocks! And I repeat it again in case people misunderstand (intentionally or unintentionally) my point here, I most definitely advocate stashing a large pile of money. I simply advocate for moving all that money into an investment with high expected returns, ideally equities, instead of letting the money languish in a money market account at 0.03% interest. Please refrain from quoting the strawman sob stories about people who couldn’t afford their roof or car repair because they live paycheck to paycheck. 

But a lot has happened since. We’ve had the 2020 recession and bear market and massive equity market volatility. Many financial experts, bloggers, and podcasters started spreading the “you need x months worth of expenses stashed away in a savings/money market account” mantra again. Have I changed my opinion? Heck no! Quite the opposite! The 2020 recession is a perfect example of the lunacy of the emergency fund invested in a money market account. Let me explain why…

The uniqueness of the 2020 Recession and Bear Market

The 2020 recession likely lasted only 2 months: February to April, though the NBER hasn’t officially announced the end of the recession yet. And the Bear Market was short, too! If we look at daily data, it lasted only 33 days (Feb 19 to March 23) and using month-end S&P 500 readings, the Bear Market lasted just three months: from the December 2019 peak to the March 2020 trough.

The recovery was also relatively swift. In contrast to the previous two Bear Markets, we’ve already achieved a new all-time high after only 7 months, even after accounting for inflation. That same task took 65 months after the 2007 market peak and 153 months after the dot-com bubble burst. And yes, it’s not a typo: after the dot-com crash the stock market never even recovered until after(!) the Global Financial Crisis, if we adjust the returns for inflation. And, yes, I am factoring in dividends along the way! See my old post from 2019 about the history of bear markets. So, in a nutshell, we went through the 2020 Bear Market in 10x or even 20x “fast-forward” mode!

Cumulative returns after the 2000, 2007, and 2019 market peaks. We went through the 2020 Bear Market in “fast-forward”!

So, this recession should bode well for the folks following my 2016 advice of simply investing the emergency fund in the stock market. Let’s extend the simulation exercise I did in 2018 to include the new data to run this until April 2021. Specifically, I simulate portfolio values after a 36-month contribution period to see whether the final portfolio value does better in a money market account (growing at the 3-month T-Bill rate) or an S&P 500 index fund (e.g. FXAIX or FNILX).

I assume that both the contributions and the final portfolio value are CPI-adjusted. In the chart below, I plot that final real portfolio value. Indeed, the emergency fund invested in the S&P 500 did slightly worse in one single month in 2020. If you were unlucky enough and your car broke down in March 2020, the money market fund would have done slightly better. The drop in March 2020 was bad enough to wipe out the 36 months of gains. Ouch!

But the stock market did significantly better during all the other months post-2010. So unless your home and your car have a tendency of breaking down when the stock market is down, you would have been better off with the emergency fund invested in stocks. On average, the stock market outperformed the money market investment by about over $3 and over 10%. Over 75% of the time you would have done better with the equity portfolio.

Final portfolio value after 36 months of $1 contributions. Side note: Notice that the money market save withdrawal amounts drop below $36 occasionally. That’s possible because there were several periods of negative real interest rates!

What about 12 months of withdrawals?

We don’t want to restrict our attention to the one-time large expenditures (e.g., major car/home repairs or medical bills). An equally appropriate purpose of the emergency fund is the hedge against a job loss. In that scenario, you would likely not withdraw the funds as one large lump sum as I assumed in the simulations above (and my 2018 post). Rather, you’d withdraw regular amounts to make up for a lost paycheck. So, let’s assume now that the 36 months of contributions of $1 each are then withdrawn in 12 equal increments over the subsequent 12 months, each at the beginning of the month. Analogously to my Safe Withdrawal Rate simulations, I solve for the level withdrawal amount that precisely exhausts the emergency fund over the subsequent 12 months. See Part 8, the mathematical appendix, for the details on how that’s done in a simple matrix. Alternatively, I could have specified a fixed withdrawal amount and then simulate the two portfolios and compare the final portfolio values. Qualitatively, with very similar results.

So, here are the sustainable withdrawal amounts from the emergency fund, see the chart below. The time stamp on the y-axis is the month of the last contribution (which implies that the final x-axis date is April 2020, because we need 12 additional monthly return observations going forward!). Quite intriguingly, the stock market investment did better even during the entire 2020 event! That’s because you had 36 months of strong returns before the pandemic and then only a very brief Sequence Risk problem during 2020, followed by an impressive rebound. Thus, even if you had lost your job in March 2020, the equity-based emergency fund would have been the better option when withdrawing over a 12-month stretch!

But just to be sure, I certainly concede this: there is a consistent underperformance of the stock market relative to the money market if you need your money during a recession, 1991 and 2020 being the only exceptions. If your job security is indeed strongly correlated with the economy one could still justify a less aggressive approach. But for all others, you’re doing better with the stock market in three-quarters of the historical simulation periods!

Emergency fund with 36 contributions and 12 subsequent equal withdrawals: The stock market did much better in 2020 than the money market!

How about aggressive savers with a 50% savings rate?

For the average FIRE enthusiast, the accumulation phase should be much shorter than 36 months. If you have a 50% savings rate you need to replace only 50% of your income, so a rough estimate would be to accumulate for 12 months to get roughly 12 months’ worth of expenditures, assuming a zero real return. How does that look in the historical simulations? Let’s see the chart below. Even in that scenario, the stock market safe withdrawal amounts never dip below the money market for the entire post-housing-crisis era. So, it’s certainly true that recessions are correlated with the stock market underperformance. But overall, the stock market will beat the money market more than 75% of the time.

12 contributions followed by 12 withdrawals: the stock market still beats the money market in 2020!

Just for the record: Do not keep 100% equities if…

  • You have retired already. I recommend keeping at least a 20-25% allocation to safe assets to hedge against Sequence Risk. Though, my research on the post-retirement glidepath shows that you can indeed shift back into 100% equities again, eventually. But notice that most financial experts would prefer bonds over a money market account because 1) the yields are slightly higher, at least most of the time, and 2) there is usually a better diversification potential with bonds because interest rates go down during most recessions and thus you get a duration effect in the bond portfolio.
  • You are nearing retirement. Traditional Target Date Funds would move you out of an aggressive asset allocation already decades before your planned retirement date. I find that way too conservative. But 2-5 years before retirement might be a good time to revisit the asset allocation and probably shift into a more cautious portfolio. See my post on pre-retirement glidepaths from earlier this year!
  • You have a strong and predictable need for taking money out of your portfolio during a recession because your business and/or employment opportunities dry up during economic downturns.

Conclusions

I thought I had written everything I needed to write about emergency funds. But today’s post was a good exercise because we could test my old theory with new data. I’m the first to concede that investing the emergency fund in stocks will sometimes backfire. But that (unconditional) probability was only 25% in historical simulations.

Also notice that I made it hard for the equity portfolio to beat the money market account. Specifically, I assumed that the emergency happens right after you are done accumulating your EF. Much more likely would be a situation where you finished accumulating your EF target and then the money just lingers there for another 1 to 5 years before you actually need it. With the additional time and runway for the equity portfolio to take off, you would find it even easier for the stock portfolio to beat the money market! (that said, the money market proponents will point to the possibility that you can shop around for higher rates. But that sounds like a lot of work. And keep in mind that interest income is less tax-efficient than the equity capital gains and dividends and the possibility of tax-loss harvesting! So, it’s probably a wash!)

What if you still have doubts? First of all, don’t fall for this myopic fallacy where you try to avoid the stock market loss over one single 36-month window. Your life is longer than that. Over your entire adult financial life, you are bound to have multiple financial emergencies. Sometimes you do better with the money market, most of the time you do better with equities. If you average the pros and cons over multiple instances you diversify that small risk more and more and you are even more likely to come out ahead with the equity investment.

And if you’re still not convinced, that’s fine too. If you sleep better with a five-figure amount sitting in a money market account, then so be it. I’m just a blogger, pointing out what would have been a better approach historically. I’m here to give good advice, not feel-good advice! But I won’t judge you if you ignore my ramblings! 🙂

Also, make sure you check out the posts on this topic:

Thanks for stopping by today! Looking forward to your comments!

Title picture credit: pixabay.com

134 thoughts on “The Emergency Fund: It’s Still Useless!

  1. Thanks for the post.
    I wonder if you know of relatively long periods of time in the history of the US or abroad when exchanges were closed, while bank accounts could be accessed ?
    (I guess for me emergency is not fixing something in the house but maybe rockets falling on the exchange or a government decision to close them 🙂 )
    P.S.
    The sentence with “thanks because” needs rephrasing.

    1. One example is after 9/11 (Tuesday), when the NYSE remained closed until Monday 9/15.

  2. Hi Karsten,

    A very timely post. I have just retired and have, this week, moved my estimate of our non-discretionary expenses for the next 5 years into ‘safe assets’. This is to mitigate against the Sequence Risk which you have well articulated.

    My dilemma is that given the historically low interest rates, I am reluctant to put these funds into bonds as it seems likely that the next move for interest rates will be up. The alternative, of course, is effectively a negative real rate of interest. Wonder what your thoughts are on this point?

    All the best.

    1. US Treasury yields are still OK. Unlike EU bonds. So, you still have a bit of room for yields to down in the case of another demand side recession.
      A recession plus inflation shock would be bad though. In that case money market or other short term fixed income will be best.
      Also: bonds are just used for diversification. Don’t sweat the low yields.

  3. I’ve tried experimenting with different levels, and have found the best for me is around 6-12 mo of cash on hand + HELOC + a ladder of CDs to feel comfortable sleeping at night =)

    The reason for the cash has been the t+3 on stocks in my local market, at least 7 days to get cash from a US-based brokerage via international wire, and even a 1 to 2 day period to move cash between local banks. My HELOC is quick (5 minutes for cash), the CC isn’t too bad, but the limit is quite low, and can’t be raised without showing full-time or self employment income so haven’t explored that further.

    I guess it all comes down to psychology and how quickly you can access cash. I think if I could sell equities and get it in 1 day then I would stash it there…

    1. I’m with you. I keep an ample amount of emergency savings in BOTH real cash (in my gun safe) and online savings account. Honestly, with all that’s going on with hacking and ransomware, I feel EVERYONE needs cold, hard cash on hand in case of an extreme emergency. Why? Because all of OUR wealth is digital. It’s only accessed online. What’s happens if you’re hacked/compromised? What if we a systematic failure nationwide, and major outages? The fact that several companies, including the Colonial Pipeline Co. have set a precedent by paying ransom to get their systems back up and running. That’s like negotiating with terrorists. Plus, our Nation’s enemies realize how vulnerable we are. I know I’ve ventured down a rabbit hole but the point is keep some cash, at least a few thousand dollars in readily available cash. If you’re worried about erosion of purchasing power due to inflationary effects, buy some silver bullion in equal amounts. I own dollar-for-dollar in pure silver bars and coinage for every dollar I keep on hand.

      1. I hear you. I keep some cash in a brokerage account because it’s the account where I trade derivatives and it’s mandated. And maybe $300 in paper money at home.
        But apart from that, I can’t get over the opportunity cost. Every $ in paper money is money I can’t grow. 🙂

      2. I am also in agreement with keeping an emergency balance of cash on hand. Everything in moderation! It is so easy to draw on past performance to point out how much one could have earned or lost. Not the point at all, in my opinion. We invest in our homes, we invest in rentals, we invest in our retirement accounts, savings accounts and more. Sensibility and safety stand to reason that an emergency fund is about a balancing act to satisfy the unforeseen costs that land on each person’s plate without disrupting all of the investments just listed. Why complicate and take on more risk when it is simply not necessary? Everyone strives for the confidence, security and SIMPLICITY of accessing money if needed, allowing the investment slice of life pie to continue doing its thing uninterrupted.My reality is that my $50K in emergency funds is a small fraction of my investments’ balances. What seems to me to be the more focused approach to emergency savings access is accumulating all of one’s investments into a Roth. I do rollovers (conversions) every year with the help of my accountant. My Roth owns properties as well. I am at 600K so far in ROTH and could tap into that for something catastrophic, if needed, fairly instantly, penalty free. My TRUE financial security is knowing my emergency fund stands guard in front of my ROTH. Extremely SIMPLE to set up and maintain. I am aware of “to each its own” for various plans, I feel like the complications and risk of trying to invest every dollar to earn creates underlying stress and more uncertainties in our choices, something i have enough of already in my retirement investments as it is.

      1. that would be a great feature to have! – the US is far ahead in the linkages between credit cards, brokerages and even tax payments via CC for miles hacking. It looks like a different planet to what we have, despite so much of our financial system being conducted digitally.

        At least I can smile to myself about the US still doing checks in the mail and weird things like that. That would be the fastest way to lose a lot of money over here =).

  4. I’ve got 4 to 5 years of normal living expenses in cash plus about twice that in bonds as part of a portfolio that is over 50% in equities. I don’t need to reach for maximum yield, and I prefer to experience less volatility than what an 80% stock portfolio will see on a regular basis. Portfolio growth just doesn’t matter much once it’s large enough.

    1. If you won the game why keep gambling? So, yes, people can take the foot off the gas once they reached a certain portfolio value.
      But I like to take a bit more risk even in retirement. Who knows, maybe I will get bored later in retirement and I Jack up our budget.

  5. I disagree in some ways but not others. I believe a emergency fund is absolutely necessary for most people.

    The reality is if you are just starting out your equity after a crash may be less then what you actually need. So early on it’s a must.

    Later on I still think it is needed. But…. An emergency fund and a safe portion of your asset allocation are essentially the same thing. They aren’t seperate except in your head. So bonds, ibonds (what I’d recommend right now for any safe asset allocation), ect cover the need just as well as a money market account with better returns and minimal hurdles to liquidity. I guess what I’m saying is sticking money in a mutual fund or savings account at today’s rates I’m with you is a poor choice. But having a non equity portion of your asset allocation is probably a smart thing for most investors at a minimum psychologically.

    1. There is ample research into asset allocation over the life cycle. For young investors just starting out you absolutely want to go with 100% equities. Otherwise, it’s going to take the average saver years or even decades to accumulate 12 months of expenses when using only a money maker account. That’s awful Sequence Risk.

      Also, I don’t think we should stress psychology too much. People have behavioral biases. Instead of encouraging folks to make suboptimal decisions, we should educate people to make batter decisions. I would find it really condescending if personal finance bloggers deemed me too dumb to understand math and finance and thus encourage readers to make suboptimal financial decisions.

      1. Depends on how young I guess. If I didn’t have at least 6 months of total assets it wouldn’t be in stocks as 3 months of assets after a crash would be too close for comfort. Sequence of return doesn’t matter if you are taken out by liquidity. Things like home equity loans don’t exist for that class of investor so not a lot of leeway. Plan for the worst hope for the best but you should always have some plan b if possible imho. What that plan b is depends on your assets and your psychological ability.

        We can argue we shouldn’t reinforce that psychology but there is a large body of evidence as to how most people will react. It’s why last March a large body of people abandoned their stock market holdings, the same in 2009. I firmly believe the right way to teach this is to encourage them to determine their risk tolerance and set appropriate asset allocation as a result so they don’t over react. If it’s 100 percent good on them, but I doubt most have the stomach for that. My guess is after a long bull market most investors are overestimating their risk tolerance.

        1. That all being said I have no concerns above a certain liquid investment level or backup plan level telling others if they can accept the risk tolerance then 100 percent is the optimal mathematical model. Hence why I shared your post ;). Now if only we could remove those pesky humans from the investing equation.

          1. Haha, funny thing is, we seem to disagree here again. For me it’s exactly the other way around. In a $1,000 portfolio the average person can suffer a 50% loss, no problem. In a $5,000,000 portfolio right before retirement, you want to take the foot off the gas. So, unless someone is really comfortable with a lot of risk, I’d normally propose people shift out of risky assets and 20-25% into safe assets around retirement.

            https://earlyretirementnow.com/2021/03/02/pre-retirement-glidepaths-swr-series-part-43/

            1. Looking in hindsight, this is pretty much what we’ve done. When we were growing our wealth on the way to FIRE, we invested 100% in equities and counted on our HELOC and dual income household to pay the bills. We could survive on one income and in the unlikely event both of us lost our jobs at the same time, we could use our HELOC. It worked out well even when occasionally, one of us was out of work. Now that we’re FIRE ready and have enough that I feel we “won” the game, I’ve backed off to 85% equities and 15% money market and ultra-short term bonds. This low risk 15% asset reserve can take us through 4 years of budgeted spend and over 7+ years if we cut back to essentials and simple extras. The cash like buffer keeps me from potentially panick selling during crashes and will give me enough sanity to ride out bears and stick to my allocation plan.

              1. That’s exactly what I recommend. In retirement, you certainly want to hedge against Seuence Risk! Glad this worked out for you. And I’m glad we are not the only ones “crazy” enough to follow this approach! 🙂

                1. Reading the other comments, I’m surprised we’re in the minority. I guess your strategy depends on your NW and what you want to do if you get to the “next level” of wealth. Say you’re $4M in NW and 50 years old. You have an eye on a $3M house on the beach. Push the risk a bit and in 5-10 years, you might be perfectly fine landing that house, taking first class vacations all the time and still feel comfortable financially. But the downside is that you may have to “scrimp by” on $2.5M if things go south. May be worth the gamble to “live large” at age 60 if this is what you desire.

                2. Yeah, that’s a great point. It disproves the “I’ve won the game, so I can play it safe now” logic. Why not keep up the game and potentially shoot the moon? Even if I don’t need to consume all that much, they may name the football stadium at the University of Minnesota after me! 🙂

        2. Why do we encourage suboptimal behavior and justify it with ” large body of evidence as to how most people will react”? Seems tautological to me.
          We also observe a lot of people that smoke and do drugs. That doesn’t mean I should endorse it.
          I like to showcase what’s mathematically optimal and let people make informed decisions.

  6. Big ERN, you know we’ll never agree, but you’re logic and mathematical support definitely support your position. I’m with Steveark above, my portfolio is large enough that I don’t need to “optimize” the return, I value the peace of mind that a cash cushion provides. Sometimes the psychological benefit outweighs the opportunity cost, glad you noted that in your final paragraph. It’s great to have friends you disagree with, a reality that’s sorely lacking in much of our society today.

          1. Slam dunk – shall we say! Ouch. I like the response. Another good point at least for me.

    1. Again: in retirement, there is ample reason for safe assets. Due to Sequence Risk. So we are most definitely bin agreement.

      But for young investors still accumulating, it’s best to go all in. There is even research to support equities plus leverage, though I don’t endorse that because retail investors don’t have easy access to affordable leverage.

      As I mentioned in the other reply: psychology doesn’t belong in finance. People have behavioral biases and instead of encouraging people to keep making those mistakes we as bloggers should inform readers about the math and science.

      1. What about levered ETFs?

        Contrary to the internet scare-mongering about constant-leverage ETFs, I think they can be a great way to achieve leverage at a relatively low cost. UPRO has a 0.92 NER and offers 3x constant leverage.

        All the scare-mongering boils down to extreme innumeracy. Yeah, I get it, if the rebalance period is daily then there’s no way a priori of guaranteeing what the return multiplier will be over any arbitrary period longer than one day. So what? That’s not in the prospectus and it’s not clear why anyone would expect otherwise.

        I will, however, offer the following mathematical caveat. If one were to estimate a probability density function of SPX returns you could reasonably argue that the density at -1 (i.e., the index goes to zero) is zero, or so vanishingly small that it could be set to zero for all intents and purposes*. The same can *not* be said of any levered position with SPX exposure, because for any levered position there is a finite SPX drawdown that results in the position losing more than 1x its value. In the case of UPRO that would be -0.33, which is an extreme daily drawdown that has never been observed empirically but I certainly wouldn’t place it outside the realm of possibility.

        * There are certainly events that would likely result in all equity valuations going immediately to zero, but they are so extreme that under such circumstances *all* assets would go to zero as well, with the possible (but hardly guaranteed) exceptions of canned goods, fuel, vehicles, weapons, and ammunition. I’m talking about imminent extinction-level-events.

        1. A little bit of leverage is one thing… 3x leverage is a LOT !!!!
          Alternatively, on a 100k portfolio, using 5K on a 3x leveraged product is ok for me (but thats me). This gives you a total of 10% extra leverage (ie 3×5 + 95 = 110)

          1. Yeah, the point is you allocate according to your risk budget. A 100% UPRO portfolio is probably not a great idea, but like you pointed out, for any given desired risk level there’s a corresponding amount that you could allocate to a levered ETF and likely achieve that risk level relatively cheaply and simply (as opposed to establishing a margin account, paying margin interest, etc.).

        2. Well, we went from no EF and 100% equities to equities with leverage. That’s a big step.
          I’m not against leverage per se. See https://earlyretirementnow.com/2016/06/07/synthetic-roth-ira/

          But I don’t like the extra fees in the leverage ETFs. It’s cheaper to do this with futures.

          Also, the criticism of leveraged ETFs is less about a total loss and more about a whipsaw and churning effect that will cause your 2x fund to return a little bit less than 2x over the long-haul.

    2. I’m also getting to the point that SteveArk and Fritz are at. One of the biggest things I’ve learned on this journey in life is what “enough” is and what it means to me. After having been to over 40 countries in the world including Afghanistan and some of the poorest on the planet, I continually try to look at what I have and how I live and realize that I’m basically a nobleman. Sure I like stuff, but I want my life defined by relationships and experiences, thus I don’t think I need to keep my foot on the portfolio gas per se. I want security, and to experience the world in a meaningful way.

      Great post though, and always something to think about

      1. Thanks for that POST… I haven’t been around the world as much as you, but I totally agree. Everything is available to us all the time !! Most countries don’t even have access to fresh produce or even running water.
        In my later years, I was always earning over 100K, but now that I’m not working I enjoy life MORE and I’m not even using all of my “forced pension of 46K”… I could probably live on 35K (supporting 4 adults) and still do everything I want to do.

  7. Love the calculations you put together for this analysis. This situation reminds me of the reasoning behind Dave Ramsey’s “Debt Snowball.” Mathematically, the debt snowball is not the optimal debt payoff strategy as it favors balance size instead of interest rate. However, psychologically, some people seem more successful at continuing to pay down debt by recognizing those early wins by paying down small balances first. The same may hold true for emergency funds since a more liquid cash instrument provides enough extra psychological satisfaction that many people won’t be comfortable with an emergency fund invested entirely in equities.

      1. Thanks for the link to your other post. I just came across your blog today and really appreciate the analytical approach to finance. It’s one reason I can’t stand some of the “big name” financial advice folks who advocate for non-optimal financial decision making. Boggles my mind how they are able to sell millions of copies of books telling people to pay off lower interest rate debt before their 29.99% credit card just because the credit card has the highest balance!

        Looking forward to reading through your past posts!

        1. Those financial advisers are talking to people who are either totally financially illiterate or seriously lacking in self discipline. No sane person would accumulate debt at 29.99% in the first place. This blog is for people who at least have the motivation or skills to improve their financial situation and are not just doing lip service to their goals.

          1. Good point! Might not work for everyone.
            But as I said before: the fixation on the EF also hurts the non-FIRE crowd where people are busy for 5-10 years (due to low savings rate) accumulating the EF and then miss out on the equity appreciation.

    1. Exactly! There is psychology and simplicity behind the risk of financial decisions that one needs to account for besides pure math! It seems to me a more desparate move to invest “all” versus most. FYI, I did the Dave Ramsey 7 baby steps years ago and it works to help manage debt. I did edit it slightly because i have enough self discipline to never have a credit card balance or buy what i cannot afford. I only use a c.card for the cash back benefit since i would be buying those budgeted items anyway. I liked the value each dollar and assigning each dollar a task. It helped me with clearer path to paying off my home early since I hate debt more than paying interest to anyone. No regrets. Incredible savings power with no debt now and a huge psychological comfort knowing the most challenging of financial circumstances could be covered because of no debt and high savings power. Thanks for talking psychology!

  8. No dude. Besides 20k in MMF I keep 50% in short and medium term bonds. That alone is more than 500k. I wonder what you’d say about that. Anyway for me the bear is always behind my back just waiting for me to ” go all equity”

    1. OK, let me try to understand: you went all in: 100% into equities in March 2020, then? Over what span of time did you shift back to 50%+ of safe assets again?

      But don’t get me wrong: 40% safe assets at the retirement date with the aim to shift back to equities over time is not a bad decision, as I showed in the SWR series, parts 19 and 20. I guess 50% is close enough and will still work.
      But if you’re still accumulating, you’re wayyyy suboptimal.

  9. What about payments to offset accounts? These reduce the principle of a mortgage. Currently mortgages rated in Australia are ~3%

    1. That’s another weak spot of the MM account. You could get a higher “return” by paying off the mortgage. Why would anyone own bonds/MM if you still have a mortgage? (I wrote a blog post about that:
      https://earlyretirementnow.com/2016/11/02/why-would-anyone-have-a-mortgage-and-a-bond-portfolio/
      The problem of course is that you can’t easily get the money back from the mortgage company unless you refinance. Hence my suggestion to use a HELOC as a buffer and emergency fund.

      1. Are the exceptions to this rule of thumb sovereign debt with positive carry (doesn’t exist right now but could again in the future), and leveraged bonds if they’re part of a risk parity strategy?

          1. Agreed! If I’m not about to retire I’d still prefer the stocks and leveraged risk parity, but if bonds have positive carry going into retirement I’d have to do some after tax return math to decide whether to pay off early or carry the mortgage. It’s irrelevant until I’m ready to build a bond tent either way!

      2. Many banks suspended access or cut HELOC limits during the 2007/2008 financial crisis, due to concern re rapidly dropping collateral values. So while an unused HELOC can provide a source of emergency liquidity under your unique circumstances, it may not be the life raft one desires during a significant recession. Likewise large unused credit cards. Diverse resources reduce this particular risk but come with attendant opportunity cost.

  10. So when you say you only keep ~$1-2k in a checking account, is it that your monthly expenses are that low or you pay off your credit cards and other expenses some other way?

    When talking about emergency funds, some people (not implying you) seem to conflate an emergency fund vs a fund they use to pay off their CC debt or living expenses every month. So it’s hard to get a bead on what people mean sometimes.

  11. What do you do when your optimal equity allocation (90%) is so far from the “feel good” equity allocation (20%)?

  12. ERN,
    Interesting article as usual.
    FWIW (not much!) I tend to side with Steveark, Fritz, et al.

    Please note these recent ‘goings-on’ with some UK credit cards:
    https://www.which.co.uk/news/2021/04/barclaycard-reduces-credit-card-spending-limits-your-rights-if-youve-been-affected/ and just how swingeing some of the cuts were!
    To date, I have not been impacted by such a squeeze. However, from memory, one of my cards did reduce the amount of my credit limit that could be withdrawn as cash from 50% to 30%.

    I am not sure if similar cuts has/have happened in the US – but possibly something to keep an eye on!

    1. I never maxed out my credit cards and simply paid the balance before the due date to avoid paying 19.9% interest. Worked for me.
      Some people mentioned that HELOCs were restricted during the trough of the financial crisis. That’s a concern. It never happened to me, though.
      So, always leave a safety cushion!

      1. Thanks for the response and the info about HELOCs.
        I guess this means that there is a risk that sufficient ‘credit’ might not be available if/when you need it.
        And folks should plan accordingly.

        1. Exactly! So, maybe budget for only half the credit line you think you have.
          I don’t consider it a huge risk, especially going forward. I think banks are in much better shape now than in 2008/9.

          1. And probably have several credit cards too – as the biggest cuts in credit limits (reportedly >90%) can only be levied against those who manage their cards properly!

      2. As an experiment, near the bottom of the March 2020 crash, I was able to do a balance transfer of over a year’s worth of expenses on just one new credit card at 15 months no interest and balance transfer fees. I probably could have a couple more years of expenses for a 3% balance transfer fee 12-18 months @ 0% on some other cards as well. It did temporarily drop my credit score from 800 to 730, but it bounced back once I paid it off this year. I’ll probably do this every 30%+ market decline going forward as an insurance policy instead of having an emergency fund.

          1. I didn’t use it as a goal of buying stocks low or anything risky, just more as proof that I don’t need an emergency fund since I have several sources of short to medium term liquidity. After the dust cleared and it was clear that my job was safe through the pandemic, I did ended up using it to buy stocks pretty low that I was already planning on buying later in the year and just gradually paid off the balance transfer before the promo rate ended.

            As a retiree, who probably won’t need to worry so much about credit scores anymore, I think it you would be fine taking out a balance transfer if another 1929/1987/2008/2020 happened again and just park it in cash in your IB account to protect yourself from potential margin calls if things ever got hairy in a flash crash situation with your put selling and/or preferred shares. Just pay it off a year later when the dust clears, paying no interest or fees. You could also use a balance transfer for unexpected lumpy five figure expenses such as in the case of a car accident or a major house repair that you could pay off in a year so you don’t need to carry an emergency fund.

      3. Just wondering if your talking “unsecured” LOC vs “secured” LOC.
        Mine is secured against the HOUSE, and I have had it for each of my homes spanning 30 years… My income is now half, and no money is ever flowing to that bank, and they have NEVER questioned me about it.

        1. Like you, I used to have a HELOC. Not anymore because now I have Interactive Brokers and I can borrow against my investments with an even lower interest rate. No need for a HELOC if I can borrow at ~1.5%.

          1. Is there some trade-off of the lower interest rate with a higher risk of the margin loan being called vs a HELOC?

          2. I sell SPX options using TD Ameritrade.

            When I sell, on Monday, put options expiring on Wednesday, the margin required doesn’t go away at 3:59PM on Wednesday. The put options do not expire at 3:59 PM on Wednesday.

            Why is this relevant?

            Because I cannot sell, on Wednesday, new put options expiring on Friday.

            I have to wait until the next day. I have to wait until Thursday morning, for the Wednesday put options to expire. Only on Thursday morning does the margin required go away. Only on Thursday morning, can I sell new put options expiring on Friday.

            How come you can sell new put options on Wednesday? Do you do it at 4:01pm or something?

            Or… am I using the wrong brokerage? Am I missing something?

            1. Had a chat with “customer support” at TD Ameritrade.

              They confirmed the trading rules used by TD Ameritrade.

              SPX options expiring on Wednesday, do not release their margin requirement on Wednesday at 4pm. The margin is released at around 6am on Thursday.

              If my Wednesday options expire OTM, then I have to wait overnight until Thursday, before I can sell a new batch of SPX options expiring Friday.

              1. How much money do you have in the account and how many puts do you short?

                Again, if you keep around $150k in equity per short put then it shouldn’t be an issue when the margin is released. You have more than enough cushion to afford 2x the margin. If you have insufficient account size, even moving to IB will not help you.

  13. This is a very solid breakdown of what you’re trading off in order to get…well, in your words “If you sleep better with a five-figure amount sitting in a money market account, then so be it.”

    I think that’s the real value in an emergency fund—the mental part—but I think it’s really important to be able to quantify what you’re “buying” for cost of keeping such a fund. Great breakdown.

    1. Thanks! But again: the sleeping better part is not a good excuse. Some people sleep better after substance abuse. I still endorse sobriety because the science trumps people’s feelings about their sleeping patterns. 😉

  14. You have recommended 20-25% to be allocated to safe assets (we are in full agreements here.)..

    What is considered a safe asset ?
    For me Gold and Cash are safer than Bonds. Yes investing in 100 years Austrian Bonds with 0.1% Interest is less safe than Gold ..
    So I am leaning towards 20% Gold, 10% Cash and 70% Equities.
    2020 has shown Gold is good hedge for system risk beside the SWR Part 34 article.
    Why we need Cash instead of Bonds:
    During certain liquidities crisis, Both Bonds, Stocks and Gold to go down at the same time … don’t take my words for it, that happened three times in the last 100 years…
    https://awealthofcommonsense.com/2017/04/what-could-cause-stocks-bonds-to-fall-together/

    1. Safe as in no equity beta. In terms of diversification potential bonds>cash (at least over the last few recessions) because of the duration effect.
      Between bonds and gold, I can see that gold has some advantages. Probably a higher real return expectation and a nice negative correlation with stocks during all the bad recessions.

      I wouldn’t trust the Carlson calculations so much. Bonds were a good diversifyer during the Great Depression. Don’t just look at 1931.
      But I get it: an inflation shock like 1970s, early 80s, would be bad for bonds. Cash is king in that environment.

  15. So refreshing to finally find a sane approach to this issue online. Every blog, FB page, IG post says the same thing: six to twelve months of income in a savings account. Why would anyone give up growth on that much money for the foreseeable future? Makes no sense. Thank you.

    1. funny like someone complains about everyone saying the same thing while at the same time assuming “growth” is a sure thing. People are so used to the bull market that they forget the what a bear is

      1. Never said that growth is a sure thing.
        Hence my point: This can go against you in any ONE SPECIFIC time window. But over many different market cycles you’re likely going to come out ahead.

    1. Yup, during that recession you would have done better with the EF. But everyone knew that.
      But during the recent recession the stock market investment would have done better. I thought that was a worthwhile topic for a blog post. 🙂

  16. I recently shaved my emergency fund and closed out of Ally when the rates dropped significantly, though in hindsight it would have been nice to do it sooner and take advantage of the COVID dip a little more. Can’t say I was upset to have the cash cushion at that particular time though either!

    1. Yeah, the EF came in handy for people who had the guts to deploy it n March 2020.
      My problem was always that even if I had a bit of a cash cushion, I’d deploy it during much smaller dips. When the big crash came I was already at 100% stocks. 🙂

  17. Once your $36 has grown to $72, you can still suffer a 50% market drop and still be no worse off. Really depends on where you baseline your account value.

  18. I’m very very conservative. 60%+ in bonds/cash. I’m still in the accumulation phase but I understand that if the stock market crashes let’s say 50% it would take a 100% jump to place me at the same initial level. Am I wrong in being so conservative? I just can’t sleep at night when I’m losing money.

    1. Yeah, that’s right. A 50% drop implies you need a 100% return. That didn’t take very long after the 2009 market bottom, though.

      Also: Have you checked how much in the upside you missed by being too conservative? You’d probably have twice the nest egg already if you had been less conservative. In fact, your current conservative allocation might have been just as bad as losing 50% with an all-stock portfolio.

    2. You still have the same number of shares even when the market drops which will likely recover in a few years and keep growing much faster than inflation. You’re likely going to need a lot of shares to be able to retire, say for example 10,000k shares of VTSAX (~$1.06 million or whatever your number is) to be able to retire. In your accumulation years, rather than worry about short term market fluctuations, just focus on accumulating a certain number of shares of VTSAX (or whatever your equity fund of choice is) that you think you’ll need. When there are market corrections, you’ll know that you’re getting more shares/$.

      Despite the market crash in 2008/09, someone who started working at 22 with no net worth in 2005 and “only” maxed out their 401k with a small match and IRA’s would be a millionaire at age 38 today by periodically investing monthly into the S&P 500. If they only put 40% rather than 100% towards equities during that time, it would likely take more than twice as long to get to a million dollars.

      1. I agree…. I was fortunate that I cashed out in early 2000 when I upsized my home… Didn’t have extra cash for about 5-7 years, and then full on Equity after that….
        So when you look at Canadian Home prices, I timed it exactly perfectly !!! I fully agree that I was lucky.
        Periodic investments are the way to go !!! With the new house we went down to one wage with 3 kids… Those early purchases in the 2010s sure did multiply !!!!

  19. Appreciate the post! What if you know you have a big expense coming up in the next couple years, like a down payment for a house or a major home renovation? I am in that situation and was intending to use the Put Selling strategy with those tranche of funds as opposed to VTI (or other market index). My thought was while it may have slightly lower returns, since my time horizon is shorter, I’m willing to trade those returns out for the lower risk.

      1. Thanks for the feedback! That article makes a lot of sense, especially for my current situation – we are looking to do a tear down where we already live, so can be flexible on purchase date. Right now we are more waiting for commodities to come back down to earth so was looking to find somewhere to park cash in the interim.

        I still like the Put Option Selling for this bucket of funds. Going back to Spintwig’s analysis in Part 6, while the historical CAGR may have been half SPY, the volatilty was 75% less with a strong Sharpe ratio (and the return doesn’t include any investments with margin cash). Max Drawdown was also significantly less. If I give up some returns in the short run on this cash, so be it – rest of my portfolio is pretty heavily equity invested so will see those gains there. And if market goes down, these funds won’t be as impacted and my broader portfolio has more time to recover until retirement.

  20. I’m with ERN on this on; for me, my brokerage account is my emergency fund; that account grows over the years… by now, even with a 35-50% drop in the market, it would not touch my principle.. I also have the choice of picking which purchase to sell (which specific transaction) since i did dollar cost avg’ing. One poster above did mention that early on, a cash emergency fund is helpful – that would allow time for your investments to grow… I have just under 3% in cash right now and only because I’m buying a car soon… but yeah, I’m happy having almost nothing in cash, use my CC if needed and pay it off the next month. Since I’m still working, I’ve never had to dip into my brokerage account for emergencies (I’ve had to get a new roof, new heater and now a car) –

  21. I too don’t have a emergency cash fund, but I do have an “emergency LOC” if required.
    I have a steady flow of dividends and Private mortgage interest to give more cashflow than I need. Plus, I do the occasional trade or two every month so that can give me extra cash if suddenly require “Loads of cash”.

  22. I’m 38 yrs old and just starting to invest now. So far I kept all my 800k in cash/gold. I’m planning to FIRE in 4 yrs. What’s your advice? All-in in the market now or not?

    1. Start slowly.. Get to know what the Stock Market nuances are….
      Predicting the market over the short term (as implied by your message) is problematic.
      Try investing $5000/week for starters, and get your feet wet……

      1. Exactly.
        Unfortunately the company I work for doesn’t let me tap into derivative market (SEC regulation).

  23. Low interest credit is so easy to obtain nowadays. If you’re gonna invest it all anyway, just open up a portfolio line of credit and commit to only using it for emergencies. Margin calls should never be an issue if the ratio of total portfolio value to total potential emergency amount necessary is 6 to 1 or some such. This is even less risky than using a HELOC as losing your home has other consequences (big disruption to kids’ lives).

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