At What Point Do You No Longer Need An Emergency Fund?

2013 January 21
by Kyle Bumpus
from → Personal Finance

The hallowed emergency fund is among the sacred cows of personal finance. Practically everybody preaches its importance and few dare to question its necessity. I personally have a moderately-sized emergency fund at ING Direct and don’t have plans to get rid of it anytime soon.

Not Everybody Needs An Emergency Fund

But does everybody need an emergency fund? Of course not! I doubt Bill Gates keeps three months of living expenses in cash “just in case.” He probably easily has three months worth of living expenses in cash at any given time, but it’s not there for emergencies. It’s just there because his investments generate a lot of cash flow. And even if they didn’t, he could easily sell a few million dollars worth of marketable securities (stocks, bonds, gold, whatever) to make up for any shortfall.

So if the white collar 9-5 worker living paycheck-t0-paycheck needs an emergency fund and Bill Gates doesn’t, where’s the cut-off? At what point do you have more than enough financial resources to weather most conceivable emergencies without needing to set aside a pile of money in low-yielding cash investments? It’s different for everybody, but you can bet I’ve come up with a few general guidelines!

 You Don’t Need An Emergency Fund If…

We’re going to start off with a few assumptions. As a general rule, you should be comfortable with (and indeed expect) to occasionally lose about half your allocation to equities during a deep bear market. For example, if your asset allocation calls for investing 80% of your portfolio in equities, you should expect to lose roughly 40% of your portfolio in a rough bear market. Likewise, if your portfolio is 100% stocks you should expect to occasionally lose as much as 50% of your portfolio from peak to trough.

For the purposes of this argument, we’re going to assume you have the riskiest portfolio possible, or 100% stocks. Thus, we’ll assume you can expect to lose up to 50% at the worst possible moment. At this point, the math is simple: do you have at least twice as much money invested in your taxable account as you would need with a cash emergency fund?

For example, let’s say you need approximately $3,000 per month to pay the bills and you’re comfortable with a 6 month emergency fund. That means you would keep approximately $18,000 in a cash emergency fund. Under this rule of thumb, however, you could skip the emergency fund entirely if you had at least 2 x $18,000 = $36,000 in your taxable account. It’s important to exclude the value of all retirement accounts including your 401k, Roth IRA, etc when making this calculation. You need $36,000 in your plain old taxable account.

Why You Might Not Care And Keep One Anyway…

Some people are just conservative investors. By my own rule, I don’t really need an emergency fund – I have well over 2  times the value of my emergency fund in my taxable account – but I choose to have one anyway. Why? For starters, I could potentially choose to go the self-employed route at any time. Now I don’t have any plans to leave my job within the next few years, but anything is possible. In that case, I feel more comfortable having a larger safety cushion than normal. Perhaps you’re worried about the stability of your job or your spouse is worried about theirs. Perhaps you want to take a year off work to travel the globe within the next few years. Or perhaps you’re just conservative like me. There’s nothing wrong with keeping an emergency fund around even though you perhaps don’t really need one.

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5 Responses
  1. 2013 January 21

    Good question! This is something I’ve been thinking about a lot lately.

    Emergency funds are really helpful for someone who doesn’t have a large net worth. I’ve realized as my net worth grows that my entire net worth is really my “emergency fund”. I just recently built up my emergency fund a bit, but I included part of my taxable investment account in my calculations. Regardless, I still like having a buffer in my checking account and then a nice buffer in an online savings account for larger problems. I also want the flexibility (financially) to be able to quit my job without another one lined up already.

  2. 2013 January 21

    Yes, the main reason I still have a cash emergency fund is that I like the freedom of being able to quit my job at any time if I wanted. I wouldn’t want to have to sell equities if I didn’t have to.

  3. 2013 January 22

    Good point. When a general account continues to grow past the point of being
    an emergency fund and you have funded everything the government will let
    you, you need to look in other places to invest money. Personally I think
    investing in first deeds of trust with a conservative equity position is about
    as good of an investment as you can find today. Especially if you can do it
    inside of a self directed roth IRA.

  4. 2013 January 25
    Jenna permalink

    Another thing to consider is how much you’d hate to have to pull out that money in a bear market.

    Maybe you keep 1-2 months of living expenses in reserve or in the cash part of your portfolio to offset that pain and minimize the chance you’d have to sell. It’s not that much to keep around.

  5. 2013 February 2

    You’re right. If a person isn’t trying to time the market and puts money into it when they have it, it should stand to reason that it would also make sense to not try to time the market and pull money out when they need it.

    That said, I can see concerns with cyclicality. For example, someone who has a lot of money in equity shares of the company they work at could find himself both out of a job and with a worthless portfolio if his company fails overnight… But that’s a good reminder that diversification means doing so not just across your investment portfolio, but also across all your money-making assets

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