financial independence

Do You Really Need That Emergency Fund?

It may be time to retire the myth of the six month emergency fund.

The Personal Finance community is feeling quite vindicated these days. According to so-called financial “experts”, the COVID recession has proven nothing if not the importance of the vaunted 6 month emergency fund. At 20% unemployment and the economy in freefall, those without at least six months expenses stored in a .00001% interest savings account will face bankruptcy, homelessness, and ruin.

But what they don’t talk about are the enormous costs associated with this – specifically, the opportunity cost of leaving a huge wad of cash in a non-performing asset.

The Cost of an Emergency Fund

Say that you, experiencing PTSD from the 2009 recession, decided to sock $50k away in a savings account back in 2010. Let’s compare your return in that scenario  vs. throwing caution to the wind, and instead investing all $50k in the stock market. By the beginning of 2020, here’s what your portfolio would look like:

Savings account option (1% return): $55,231

Stock market option: $144,489 (I actually extended this through April of this year to take the 2020 crash into account)

That’s a difference of nearly $90,000, almost enough to buy the economical but badass Porsche 911.

But what if …?

Of course, the real danger is that you put your money into performing assets, they don’t perform and you get hit with a job loss, medical issue, or economic collapse. For example: say you invested your $50k in the markets, they fell by 70% in Year 1, and now you are left with $15k to cover your $8k monthly nut.

I still  think that for many people, the emergency fund is unnecessary. Just that $15k will be enough to keep you afloat in you fall into one of these categories:

People with passive income: if you lose your job and it’s your only course of income, then yes I can see the need for ample emergency funds. But what if, say, rental income covers all or part of your expenses? Despite all the media hype about rent strikes, there are relatively few people actually not paying rent theses days. Likewise, revenue from bonds, annuities, etc. tends to be a lot more reliable than employment income. So there’s little chance you’ll be facing a situation with zero dollars coming in every month.

Older people: If you’re living off of social security, pension income, and mandatory 401k distributions, then what’s the point of an “emergency fund”? Most of those income streams are guaranteed, and even the 401k income will be unlikely to drop more than, say 50% in any given year. So obviously the truly retired have to worry far less about an emergency fund.

People with credit cards: Between all my credit cards, I have about $170k in total credit. And none of them have a fee attached. Yes of course many banks are now limiting or shutting down lines of credit – but not all of them. Even if half shut down I could probably coast at least a year on my existing credit, even with $0 coming in from elsewhere. And that doesn’t even assume that I cut any of my ridiculous expenses (see below).

People with HELOCs: HELOCs often are shut down in recessions, but you can always withdraw a huge chunk at the first hint of trouble and use that as your emergency fund. In 2009-2010, I quickly snatched $110k out of my HELOC and bought a luxury condo for cash. The rental income covered more than double the interest payments and I sold it for double what I paid five years later. But you can also use the money to live on until things pick up.

People with assets: if you don’t mind having to sell stocks, property or collectibles, this is another way to reduce or eliminate the need for an emergency fund. Granted, you may need to sell at a loss, but compare that loss to the opportunity cost of having your money non-performing for years or even decades.

People with goofy, unnecessary expenses: during this quarantine, my expenses miraculously dropped about 80%, helping me to realize how truly disposable so much of my spending is. If you are like me and spend a large portion of your income on travel, entertainment, home improvements and/or clothes , then you can probably get by with vastly less than 6 months in cash.

People whose income is linked to the economy: In boom times, an emergency fund is less important. It will be pretty easy to find another job. But what about in an economic collapse? Well, usually Uncle Sam shows up with some cash to cushion the blow. For example, during COVID, the following are on offer:

  • Additional unemployment benefits
  • For business owners and contractors, PPP and EIDL
  • Mortgage relief
  • Credit card payment relief
  • Cash stimulus payments
  • Penalty free 401k withdrawals

And that’s just what they’ve offered so far. All of these go a long way towards extending or replacing that emergency fund.

So Can I Get By With Sofa Cushion Money?

The point of this post is not to claim that no one needs a 6 month emergency fund. People with high fixed expenses, young families, medical issues, no assets and/or no credit are good candidates for at least some emergency fund. I’m just saying that 6 months can be excessive for most people and entail massive opportunity costs.

You should carefully evaluate your own situation, and what options could be available to you, before you hand Wells Fargo, Bank of America, or even Ally a huge wad of cash to sit interest free for years at a time.

Making your money work as hard as possible for you (vs. the other way around) is the best path to FI, –  so don’t let the emergency fund myth let that cash slack off for even a minute.

Additional Reading/Inspiration

Here are some other insights on emergency funds by some pretty sharp bloggers. You should check them out!

Poorer Than You: How Big Should Your Emergency Fund Be

DINKs Finance: Why Should Building an Emergency Fund Be a Priority

Your Money Geek: The Ultimate Guide on Emergency Funds

The Frugal Fellow: The Only Guide You Need on Emergency Funds

White Coat Investor: Why You May Not Need an Emergency Fund

Have you gotten away without an emergency fund? How? Tell us about it in the comments below!

9 replies »

  1. The math supports you, and you make great points. It’s not what we did, we were on the crazy conservative side, probably a generational thing. But no doubt we’d have more assets if we had done it your way. Fortunately we’ve got way more than we need, but that’s certainly not true for everyone. You did a good job covering the exceptions too. Very balanced presentation!

  2. One thing about the emergency fund is that I think most people think it’s either get no return on it or invest it all. There’s actually a sor t of middle ground that most people don’t know about where you can get 5% or more in FDIC insured accounts with no risk of loss – I think it’s sort of the best of all worlds. It does require some setup work and/or regular work, so it’s best suited for the type of person that’s into optimizing and travel hacking and that kind of thing.

    Personally, my wife and I have $42,000 earning 5% interest in FDIC insured accounts via Insight (grandfathered in), Netspend, and Digital Federal Credit Union. I then always try to keep a stash of cash to use for bank account bonuses, which typically get yields of around 10% to 25% with no risk of loss – obviously does require some work, but once you’re used to them, it’s not that bad.

    That’s how I’ve treated the emergency fund game anyway – sort of getting the best of all worlds this way.

    • One thing about the emergency fund is that I think most people think it’s either get no return on it or invest it all. There’s actually a sor t of middle ground that most people don’t know about where you can get 5% or more in FDIC insured accounts with no risk of loss – I think it’s sort of the best of all worlds. It does require some setup work and/or regular work, so it’s best suited for the type of person that’s into optimizing and travel hacking and that kind of thing.

      Personally, my wife and I have $42,000 earning 5% interest in FDIC insured accounts via Insight (grandfathered in), Netspend, and Digital Federal Credit Union. I then always try to keep a stash of cash to use for bank account bonuses, which typically get yields of around 10% to 25% with no risk of loss – obviously does require some work, but once you’re used to them, it’s not that bad.

      That’s how I’ve treated the emergency fund game anyway – sort of getting the best of all worlds this way.

    • Great suggestions. I checked out DFCU and was pleasantly surprised to see a 6% interest rate. There is a $1,000 limit though, apparently. Netspend and Insight looked to be prepaid cards, so I wasn’t sure how to earn interest on these (any ideas?). Thanks for the suggestions!

      • I’ve written a really thorough post on this financial hack on my blog. Takes some upfront work, but once set up, it runs automatically – have had them going automatically since 2016 with zero issues. Insight unfortunately took away the 5%, although it’s still possible to get it if you can get the card in person somewhere. Some people have done that, but I’m not sure the logistics of getting the Insight card in person.

        Still, with Netspend, you can do 5 cards each earning 1k at 5% interest. Then DCU earning 6.17% for 1k. Open accounts for your spouse and now you’ve got $12k earning 5% interest. That’s a solid emergency fund for most people.

        Link to my Netspend post here if it’s okay to share that link. https://financialpanther.com/netspend-account/

  3. Interesting perspective. When the crisis first started, I upped my emergency fund from 3-6 months of expenses because I‘m self employed and feared loss of income. Didn’t end up happening, but either way I would’ve been fine. Since nobody else seems to have an e. fund, the gov‘t was quick to offer help.

    For me the benefit is purely psychological. But it‘s also a very small sum (comparatively) since my expenses are quite low, so it doesn‘t actually make a huge difference.

    • I don’t think there is a “one size fits all” rule here – everyone’s circumstances are different. 3-6 months looks to make sense for you given your situation. Thanks for the feedback!

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