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About investing emergency fund in stocks

August 30th, 2014 at 03:39 am

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.

3 Responses to “About investing emergency fund in stocks”

  1. Rachael777 Says:
    1409408627

    when I am more stable and have more cash I am going to be doing the same thing investing part of my emergency fund and part of the other funds I just 'hold' for growth. Balanced risk is the key. Bravo to you! Smile

  2. Dental Floss Tycoon Says:
    1409516490

    You make some great points. With savings accounts rates staying low into the near future, inflation will exceed those savings rates, and erode the future purchasing power of the Emergency Fund. If your EF is only a month or two of expenses, then the ravages of inflation may not be so detrimental. But, is your EF is substantial enough to cover a year or two of expenses, then inflation needs to be considered.

    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

  3. SecretarySaving Says:
    1409777757

    The emergency fund is not an investment. You are treating it like one. I have a fully funded 6mth worth of expenses in a savings account. It doesn't earn anything and I could care less. In addition to that I also have my 401K, Roth IRA, College Fund and am paying off my house. When the house is paid for then I will invest that payment. I worked for Enron and saw a lot of people lose their retirement because they had so much of it invested in company stock. That hit home and I will never use an investment as an emergency fund. Dave Ramseys says if you needed $5K today to get a vaccine to save your child's life I could get it asap. You'd have to sell your stock then get it and who knows what your stock will be worth.

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