Do you have an Emergency Fund?

To me, an ’emergency’ is usually something like a problem with the house or car, losing/changing jobs, or a health problem. These are all real and can all take significant chunks of cash …

… but, if you can reasonably forecast their likelihood up front (i.e. you have a family member with a known or suspected ‘condition’; a crappy house/car/job; etc.), then they’re not ’emergencies’ – in my book, they are ‘time bombs’ – and you should be budgeting/saving a specific amount to cover the expected cost + a margin of safety, as best you can.

They are not ’emergencies’ for the sake of this post …

… they are the unfortunate realities of your life and you need to prepare for them properly – even if it has to come at the short-term ‘expense’ of your Investment Strategy.

No, what I am talking about is the ‘lucky majority’ who have good jobs, homes, cars, health – besides partying VERY hard to celebrate our good fortune – how much of an Emergency Fund should we have?

1 month? 3 months? 6 months? More?

OK, let’s bust the myth of keeping 3 to 6 months cash sitting in an Emergency Fund!

Never had one, don’t want one … and, if I was to keep one, it would have 2 years of income sitting in it (in a mixture of redeemable bonds, cash in various currencies, and gold coins/bullion) so that I could run and survive “when the [insert disaster of choice: Russians/Arabs/WWIII] come”.

So, does that mean that I don’t have cash?! Hell no … it’s just that it’s not for emergencies … it’s for investing. And, as I said, when I was still building my wealth, I never kept an emergency fund.

We did keep cash surplus for unexpected bills, etc. but never more than a month or two of income … at least, not for long … here’s why:

What happens if no emergencies crop up in the next 5 years?

If you had $10,000 sitting in an Emergency Fund (e.g. CD’s) you would have earned nearly $1,700.

If you had $10,000 sitting in an Index Fund you would have earned nearly $3,500.

 

What happens if no emergencies crop up in the next 10 years?

If you had $10,000 sitting in an Emergency Fund (e.g. CD’s) you would have earned nearly $4,200.

If you had $10,000 sitting in an Index Fund you would have earned nearly $10,000.

 

What happens if no emergencies crop up in the next 20 years?

If you had $10,000 sitting in an Emergency Fund (e.g. CD’s) you would have earned nearly $11,000.

If you had $10,000 sitting in an Index Fund you would have earned nearly $33,000.

Get the picture …. that’s a $22,000 ‘premium’ to cover a possible emergency!

It gets better ….

What if you had committed that $10,000 to a deposit on a $100,000 house? Over 20 years, it would have increased your Net Worth nearly $200,000 !

So, are you willing to pay a $200,000 premium for an insurance ‘insurance policy’ against an emergency?

But, what would I do if an emergency arises:

1. If it’s a ‘planned’ emergency of the kind that I mentioned before, I would borrow against the house, or sell down my stocks ahead of time and put the money aside well ahead of expected use.

2. If it’s an ‘unplanned emergency’ then I would already have taken a HELOC against my home – and, in the event of such an emergency, I would simply draw against it, and put in place a plan to pay it back.

Sure it will cost interest, but that’s the gamble that I took – even if it takes me 5 years to pay it back, the interest bill will pale against the increases that I made by investing those funds (and will continue to make, when I get the debt paid off and my feet back on the ground).

Warning Advanced Strategy: What do I do?

Well, I always pay cash for my houses, but then I take out as big of a HELOC as my wife and bank will allow me (usually more than 50% of the equity that I hold).

Then I draw down the full value of that HELOC and invest in individual stocks (an Index Fund is a fine alternative for the purposes of what we are discussing) … if I happen to need the money for an emergency, I sell off all or part of my investment and divert the HELOC borrowings to that use. So far, I haven’t had to. 

Loss on the stock? That’s market timing, which is why this is an ’emergency strategy’ only …

… the key is not to take a certain hit on your finances for the possible loss in an emergency. Equally, it means not sticking your head in the sand, and having a contingency plan in place i.e. a way to deal with emergencies if they do crop up.