For most of my life I’ve had about 6 – 12 months of living expenses sitting in cash in my checking account. This cash is my “emergency fund”.
I’ve always felt fine about this because of these old-school popular money beliefs:
- Cash is king
- Cash solves problems quickly
- Holding cash allows me to jump on opportunities if they arise.
- Financial gurus say it’s important to have an “emergency fund”.
- Most Americans are cash poor, and since I never want to be like that, I should blindly do the opposite.
- If I ever lose my job, a cash pile lets me live for 6 to 12 months with no income.
- Cash can cover an emergency health/dental/car/pet/travel expense without touching my “other investments”.
- Bla bla bla, emergency funds are smart and anyone without one will be financially ruined.
This was my old way of thinking.
Now, my thoughts on emergency funds are changing…
I’m starting to question conventional wisdom and am realizing that holding a 6 month cash “emergency fund” might be hurting me more than helping me.
My money beliefs are shifting… Here are my new thoughts on cash emergency funds:
- Cash is a burden. It is counterproductive to my wealth building mission.
- Cash isn’t important — access to cash is.
- Having an emergency fund is less important than having an emergency PLAN.
- An emergency fund doesn’t prevent emergencies from happening. There’s no reason to feel “safer” with cash in a checking account.
- In reality, my entire net worth IS my “emergency fund”.
- If I lose my job, I can actually live for ~15-20 years without income if need be.
- I shouldn’t blindly follow financial gurus, they can be wrong about a lot of things.
- If I have a large unexpected health/dental/car/pet/travel expense, paying with cash is only 1 of many payment options.
Soooo… With all this being said, I’m thinking about ditching my emergency fund and dumping all my cash into the stock market.
Am I crazy?
(don’t answer that just yet…)
Reasons to have a $0.00 emergency fund:
Don’t worry, I won’t make any drastic changes without fully researching and thinking this through.
There are a handful of FIRE bloggers (way smarter and more experienced than I) that believe in holding $0 in cash. Probably the one I’m a biggest fan of is Karsten (aka Big ERN) over at Early Retirement Now.
ERN has written multiple blogs over the past 6 years about why emergency funds are crap, and why people should consider having ALL their money invested and working for them instead. I’ve read all the related posts, and love that his research includes both technical simulations as well as psychological reasons to support his points.
I’ll reference ERN’s posts within this article, but here’s a quick summary of reasons why it’s better to hold as little cash as possible:
1. Opportunity cost. For every dollar you hold in cash, that’s a dollar that’s not working for you earning better returns.
a) In most cases, it’s financially better to invest your emergency fund (and withdraw the money from your investments when you need it) vs. hold a large cash pile to use if/when you have an emergency. The math doesn’t work out all of the time, it works out most of the time (like 75%).
b) ERN goes into extreme detail in this 2018 post about investing your emergency fund in stocks, and again with new data, proving the emergency fund is still useless even after last year’s massive recession!
c) Just FYI… The reason most people still keep emergency funds in cash — even though they might know it’s mathematically better not to — is because they sleep better at night that way. There’s nothing wrong with this! Sometimes people are more worried about the small chance of loss, vs. excited about the higher probability of gain. We are all humans and it’s cool to feel this way. But I personally am trying not to.
2. Holding cash leads to behavior biases. I have definitely fallen into these mental accounting traps that can lead to making bad decisions…
a) Having a big cash pile makes it more tempting to spend. When I wake up every morning and see $30k in my joint checking account, there’s more of a chance I’ll tell my wife we can “afford to” go on a $3k luxury vacation vs. if we held only $1k in our checking account. Making cash less accessible reduces unplanned spending.
b) Emergency funds skew our view of risk. People think their entire portfolio is divided into “buckets”, and that each bucket has a different level of risk. But really we should take into account our entire portfolio when evaluating risk. For example, I could probably invest my $30k emergency cash into stocks, then with some minor asset shuffling in my brokerage account, achieve the exact same overall risk I have now, with a higher return. (Or, achieve the same return I am getting now, but with a lower amount of risk). Make sense? Very interesting *and more advanced* post about that here.
c) The longer you hold large amounts of cash, the more emotional attachment you have to it. Remember my friend with $200k in her checking account? As each day goes on, she gets more and more scared to do something with it. Same with me and my ~$30k emergency fund. I’ve had it in my checking account for over 15 years!!! If an emergency does happen and I truly need $30k, I will probably sell some assets to cover the expense, vs. using my emergency cash. Why? Because I can’t fathom the thought of not waking up and seeing my “artificial safety net” there. This bleeds into the next point below.
3. If an emergency happens, and you use your fund, then what? Following up on what I mentioned above, let’s say I have an emergency and need to spend my $30k emergency cash. What happens next? How do I replenish my fund? Well, I’d either need to a) scramble and save money over the following months to pay back my emergency fund or b) withdraw money from my brokerage account to replenish the $30k in cash I just spent. Both of these scenarios are the same if I held $0 in cash. If an emergency happened I’d either need to a) scramble to save and pay back money to wherever I borrowed it from or b) sell assets to cover it. Same scrabble or selling whether I have cash or not.
4. 10 other debunked myths about holding emergency cash. ERN has written a 2-part post about these “emergency fund myths” and responded to countless people who disagree with his point of view. These 10 points are so interesting to read!!
Accessing money in an emergency…
OK, let’s suppose I put all my emergency cash into investments and go down to a $0.00 emergency fund… What happens if disaster strikes? What happens if my car suddenly dies and I need $15k to buy another one? What if a medical emergency rolls around and I’m stuck with a $14k out of pocket bill? What if my wife and I lose our jobs at exactly the same time?
Here are some options for us to pay for things (in no particular order):
1. Credit cards could cover most immediate expenses (my wife and I have a whopping $107,100 in available credit across 11 open cards). We would never spend that much, but it’s the quickest way to pay for emergencies with 20-50 day interest free payment terms. There are also ways to roll credit over with longer interest free periods we could take advantage of.
2. Borrow money from our Rental Property Emergency Fund. We have about 20k sitting in cash in our rental property float account. Borrowing from this doesn’t cost us anything. (I’ll delve into later why this account will remain in cash – I’ve always kept rental property accounts completely separate from personal accounts)
3. Liquidate stocks to pay for an emergency. This could be done in a lump sum to pay for a large expense (like $15k for a new car) or done slowly over time to pay living expenses in the case of job loss (eg. withdraw $5k monthly for however long we need to live off it). Obviously this is a last resort option if we happen to experience a disaster *during* a large stock market crash.
4. Securities-based line of credit, aka “margin account”. This is like a home equity line of credit, but, instead of using a house as collateral for a loan, our brokerage firm (TD Ameritrade) will lend us money using our taxable brokerage account as collateral. The available amount we can borrow is based on our account value and the positions we hold. As of today, TD will lend us up to $123k in cash, payable by WIRE or bank transfer. The current TD interest rate is 9.5%, so we could borrow $10,000, and pay about $2.60 in interest per day for each day until we pay it off. Not ideal, but certainly not horrible in an emergency situation!
5. Cover the expense with new earned money: For a small emergency, like covering a $5k unexpected expense, there’s a chance my wife and I can cover this from our regular paychecks in the course of a month or two. We don’t have a huge savings rate right now as we are just ramping back up into work, but some months we have a larger savings rate (higher than usual income + lower than usual expenses). If a disaster comes in one of those months, we may just be able to cover it without touching investments anyway.
6. Borrow from friends/family. I sound like a jack-ass admitting this, but my wife and I are incredibly blessed with close friends and family in fairly well off positions. There’s potential that we could borrow large chunks of money from them (based on the fact they know we are “good for it”). I’ve personally lent $25,000 to a friend in the past who was in a tight cash spot, and they paid it back in 60 days. I believe some of my friends today would do the same for me, although this would be a last resort type option.
7. Combo of the above. Depending on the emergency, we could do a blend or mix of the above methods.
Downsizing my emergency fund…
So, here’s my current situation…
My wife and I have about $35k in cash. We are kind of on the Coast FI train, and our savings rate for this year will probably be like 15% or so (some months lower, some months higher due to irregular monthly income). We are still up in the air about our exact FI number, but it’s safe to say “retirement” will be 7+ years away at our current rate, maybe longer. We are not risk averse, mostly because of our age and lifestyle (no kids yet, don’t own home yet, can happily kick into frugal overdrive to cut back spending if needed, etc)
All that being said, I’m 90% convinced that we can drop our $35k emergency cash fund down to ~$10k without having any major cash flow issues. The only reason I don’t feel comfortable dropping down to a $0 cash position (yet) is because of some possible travel plans at the end of this year (planning Aus for Christmas if they open the borders) and also my wife is unpaid for the summer as a teacher.
Pending agreement from my wife and an analysis on where to invest the $25k cash, I might actually do this…
Am I crazy?
(ok, now you can answer!)