This post is inspired by Snafu's question on my last blog entry. I posted this on a forum, but since I'm looking for arguments or possible scenarios that I am overlooking where this can be a problem, I also wanted to share it here and get your thoughts:
Investing emergency fund is a big no-no according to all financial advisers out there.
But is it really best advice for everyone?
The recommended wisdom is 3-6 month of expenses, in a super safe place like FDIC insured accounts, earning effectively nothing.
Dave Ramsey says "Emergency Fund is insurance, not investment."
Lets examine the cost of that insurance.
Say I have 80K emergency fund. (8K per month expenses). Losing 5% to inflation a year (I know official number is 2-3%, but it excludes many things we actually consume, like food(especially organic) and fuel, and other items). So that's $4,000 a year. Assuming, conservatively, that you can make 6% per year average in the market, that's another 4,800 it is costing you to have that as insurance. So overall, $8,800 per year for 80K of insurance. That is one expensive insurance! In comparison, it costs about 1/10th of that to buy 1 Million dollars of life insurance.
The argument is " what if at the same time you lose your job or need the money, the market happens to be tanking 40%, like at the height of the financial crisis? "
My strategy is to balance that risk by having 10 months of invested take home pay instead of 6 months of savings sitting in a savings account.. That way, on the unlikely chance of this convergence of bad luck, I still would have that 6 months to fall back on. And in the meantime, that money is utilized.
I am not a good saver, and most of the savings in our 10 month EF came from growth. I would not have that money to begin with if I was not investing. I think I would at best still have 3 month only.
This year, our EF increased by 23K YTD and is finally at 10 month of take-home pay. Only about 4-5K of this 23K came from new savings. The rest was growth and some trading. So assuming the worst case scenario of a 40% drop, overall, I would still be ahead of where I would be if I followed conventional wisdom of "no risk is allowed for Emergency Fund".
When the market goes down, and the balance of my accounts goes down, I try to add new money to keep it at the same level. [/b] That forces me to invest when market is going down, not when it is going up, which is a good long term strategy.[/b] And when it recovers, my fund grows.
There are other personal circumstances that contribute to this decision: we could cash flow minor emergencies such as car repairs or small medical bills, our jobs are very stable, we have 1-2 months of annual leave banked at any given time, and a little bit of cash in accounts. So we won't need to access that money unless the emergency is major.
About investing emergency fund in stocks
August 30th, 2014 at 03:39 am
August 30th, 2014 at 03:23 pm 1409408627
August 31st, 2014 at 09:21 pm 1409516490
Another consideration is how fast one can access the EF. I don't think I would need immediate access to the entire multi-year total of expenses. Mine runs the range of being in a brick and mortar a couple miles away, to being a few mouse clicks away online, to taking a few days of settlement and bank transfers.
I have a three bucket approach of various time periods for my emergency funds.
Short Term - Cash Accounts
Intermediate Term - Bonds and Bond Fund Accounts
Long Term - ETFs and Mutual Fund Accounts
My EF can be found here:
http://dental-floss-tycoon.savingadvice.com/savings-plan.html
September 3rd, 2014 at 09:55 pm 1409777757