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.
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!