Author Topic: Emergency fund during a downturn  (Read 1907 times)

Gumption

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Emergency fund during a downturn
« on: October 12, 2017, 08:43:04 AM »
After reading the following article I am been considering my emergency fund.

https://blog.wealthfront.com/no-need-to-fear-market-corrections/

I started my work career and investing in 1999, so I was a part of the dot.com bubble, but I didn't have that much money at risk. I did, however, have more skin in the game during the 2007 collapse, so I know how it is to get a brokerage statement showing a -47% return on my porfolio. Ouch.

No doubt, it will happen again at some point.

Yes, I know I can't time the market, so please don't let the hounds out on me for that one.

I am looking at FIRE 2020 and my consideration now is that I am thinking of padding my emergency fund with 2 years worth of cash (money market or higher rate saving account.) In the event of a downturn in FIRE, I would switch to this source while my portfolio heals. As the article alludes to, historically, you wouldn't be looking at more that 18 months for your portfolio to be back where it was before the crash.

I have maxed out my IRAs and my 401k and HSA this year, so all excess funds have been going into a brokerage.

Thoughts? Face punches?

I know the 4% rule accounts for events like this, but I would hate to use invested funds that have just lost half their value.

ixtap

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Re: Emergency fund during a downturn
« Reply #1 on: October 12, 2017, 08:50:04 AM »
Have you looked into a CD ladder? FDIC insured, best rates for safe money...you could view it as the bond portion of your portfolio, or at least a piece of it.

acroy

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Re: Emergency fund during a downturn
« Reply #2 on: October 12, 2017, 08:55:11 AM »
don't do it - keep you standard 3mo, 6mo, whatever.

People hate the loss more than they want the gain. Known human nature. I'm tempted by it too. But, 2yrs of living expenses in cash or equivalent will reduce long-term returns
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Another Reader

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Re: Emergency fund during a downturn
« Reply #3 on: October 12, 2017, 09:09:25 AM »
You are facing "sequence of returns risk".  One way to deal with it is to become much more conservative as you retire.  Once you get beyond the first few years, you can actually increase your risk by adding more equities.

I'm older, so most people that I know have pensions to cover some or all of their expenses.  Those that do not usually keep one to three years of anticipated expenses in safe, more cash-like investments.  This is discussed a lot over at early-retirement.org, which is frequented by a generally older, more cautious crowd.  Worth a look.

NorthernBlitz

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Re: Emergency fund during a downturn
« Reply #4 on: October 12, 2017, 09:44:04 AM »
Have you looked into a CD ladder? FDIC insured, best rates for safe money...you could view it as the bond portion of your portfolio, or at least a piece of it.

I just put money in an online savings account over a CD ladder.

For example, Ally has their CDs at 1.35% and their savings accounts at 1.2%.

I prefer the liquidity of the savings account to the extra 0.15% from the CD.

Laura33

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Re: Emergency fund during a downturn
« Reply #5 on: October 12, 2017, 10:15:21 AM »
I think you're talking about two different things here.  The EF is for major life events, like losing your job.  That can be more or less depending on your needs and situation (e.g., if you are the sole breadwinner and it will likely take a long time to find a comparable job, you need a bigger EF than a family with two incomes that can get by on one).  You want this in something safe, because frequently the kinds of economic events that cause major job losses also cause the stock market to crash.  Some here think you can use a line of credit or CC to serve as an EF, on the theory that you can pay it back quickly when you get the new job; personally, I am not comfortable with that, because the last Recession showed that companies can be quick to cut credit in a crash (ask me how I know).

The other situation in which you need to worry about being forced to sell low is after you are already FIREd.  In that case, you want enough money in safer instruments so you aren't forced to sell low to cover your living expenses, because having to sell low shortly after you FIRE increases the risk that you will run out of money over your RE period.  But this isn't an EF so much as just your overall asset allocation.  In this case, you don't want to rely on CCs/HELOCs, because you aren't planning on getting a new job again to replenish that income.  Some people (including me) deal with this by having some money in laddered bonds or CDs so they can survive a few years without selling investments. Others manage this by having a more conservative stock/bond split and selling off the one that isn't in the tank.
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Imma

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Re: Emergency fund during a downturn
« Reply #6 on: October 12, 2017, 10:40:39 AM »
If you are close to FIRE, it is wise to keep a relatively large amount of money in a non-investment account where you can easily access it. I think many people on MMM are a bit reckless when it comes to this. No, money in an account like that doesn't work for you like investments do, but peace of mind is worth something. If you are too young to get some kind of work pension or social security, and especially if you have a family, I would make sure to have 1 - 2 years of expenses in an emergency fund.

Theoretically, you can get a new job if you've already FIRE'd, but it is entirely possible that after a few years of retirement your skills need some brushing up. You might not be able to get the kind of high paying job you used to have.

gluskap

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Re: Emergency fund during a downturn
« Reply #7 on: October 12, 2017, 10:56:37 AM »
I've been thinking about this a lot too.  I plan to have about 2 years worth of expenses in bonds and the rest in stocks.

ixtap

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Re: Emergency fund during a downturn
« Reply #8 on: October 12, 2017, 11:08:46 AM »
Have you looked into a CD ladder? FDIC insured, best rates for safe money...you could view it as the bond portion of your portfolio, or at least a piece of it.

I just put money in an online savings account over a CD ladder.

For example, Ally has their CDs at 1.35% and their savings accounts at 1.2%.

I prefer the liquidity of the savings account to the extra 0.15% from the CD.

5 years are 2.35%, no early withdrawal penalties. And the whole point of the OP was to have this money down the road.

Eric

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Re: Emergency fund during a downturn
« Reply #9 on: October 12, 2017, 11:12:51 AM »
You should read this Kitces post before deciding.  He argues the opposite.  That the drag on your cash is likely to leave you with less money than simply investing it and absorbing the drop.

https://www.kitces.com/blog/research-reveals-cash-reserve-strategies-dont-work-unless-youre-a-good-market-timer/
"Compound interest is the most powerful force in the universe."  -- Einstein

Rhoon

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Re: Emergency fund during a downturn
« Reply #10 on: October 12, 2017, 12:50:21 PM »
You should read this Kitces post before deciding.  He argues the opposite.  That the drag on your cash is likely to leave you with less money than simply investing it and absorbing the drop.

https://www.kitces.com/blog/research-reveals-cash-reserve-strategies-dont-work-unless-youre-a-good-market-timer/

Found an interesting article via the comments:

http://www.twenty-first.com/pdf/Evensky-Ret_Inc_Redesign.pdf

Worth the read.

Gumption

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Re: Emergency fund during a downturn
« Reply #11 on: October 12, 2017, 01:06:38 PM »
Thanks for the replies. Ill need to read some of the links people sent.
I like the idea of putting into a high savings savings account. One to 2 year CDs seem to be about 1.7% and Ally seems to be around 1.2%, so ill take the liquidity.
Also I like the idea of this sum being part of the Bond portion of my 80/20 portfolio.

I am early 40s, so years away from being able to access SS.

Yes, in the long run, it will probably have a drag on the overall portfolio; but when you are close to pulling the ripcord, you need to be more agile with with may be thrown your way.
« Last Edit: October 12, 2017, 01:14:10 PM by Gumption »

Eric

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Re: Emergency fund during a downturn
« Reply #12 on: October 12, 2017, 01:55:05 PM »
Yes, in the long run, it will probably have a drag on the overall portfolio; but when you are close to pulling the ripcord, you need to be more agile with with may be thrown your way.

Ahh, well then maybe what you're actually looking for is something to reduce sequence of returns risk for early in your retirement, as opposed to holding cash for the length of it.  Check out this article on using a Bond Tent.  The basic premise is that you change your AA to increase your bond percentage shortly before (or at) retirement, and then spend through those bonds for the first 5-10 years to get you back to a more aggressive AA.  This way you are somewhat protected against an early market drop but also will maintain the growth needed for a long retirement.

Personally, I'm planning a modified version of this when I plan to quit in early 2019, since I could never go 30/70 stock/bond as shown in the article as that's just too conservative.  I'm also not starting until retirement, since if there's a big drop in the near future, I would just keep working.  Instead, I plan to start at 60/40 and then spend/rebalance from bonds 5% per year until I'm back to my desired 80/20 allocation.

It's not a free lunch though.  I'd end up with a lower portfolio value if the market had 5 great years right after retirement.  But of course, my goal is to help mitigate some of the downside risk more than I'm concerned with losing out on "big money".

"Compound interest is the most powerful force in the universe."  -- Einstein

Gumption

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Re: Emergency fund during a downturn
« Reply #13 on: October 18, 2017, 09:55:15 AM »
After researching it, I decided to put what was in my emergency stash to Vanguard Total Bond. As its in a brokerage fund, I can access it. It is certainly has more risk than Money market, CDs or the like; but, I think, historically speaking, that risk is low.

I am still targeting the 80/20 mix...but that 20% I can fill in with the brokerage side of my portfolio and all the pretax 401k, IRA, HSA monies will go to stock.

GlassStash

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Re: Emergency fund during a downturn
« Reply #14 on: October 18, 2017, 10:04:47 AM »
After researching it, I decided to put what was in my emergency stash to Vanguard Total Bond. As its in a brokerage fund, I can access it. It is certainly has more risk than Money market, CDs or the like; but, I think, historically speaking, that risk is low.

I am still targeting the 80/20 mix...but that 20% I can fill in with the brokerage side of my portfolio and all the pretax 401k, IRA, HSA monies will go to stock.

I do not know what your tax situation will be when you retire, but you should also keep in mind tax efficiency. See https://www.bogleheads.org/wiki/Tax-efficient_fund_placement.
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Gumption

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Re: Emergency fund during a downturn
« Reply #15 on: October 18, 2017, 10:22:46 AM »
2020..thanks for the link, ill take a look

Another Reader

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Re: Emergency fund during a downturn
« Reply #16 on: October 19, 2017, 07:05:51 AM »
After researching it, I decided to put what was in my emergency stash to Vanguard Total Bond. As its in a brokerage fund, I can access it. It is certainly has more risk than Money market, CDs or the like; but, I think, historically speaking, that risk is low.

I am still targeting the 80/20 mix...but that 20% I can fill in with the brokerage side of my portfolio and all the pretax 401k, IRA, HSA monies will go to stock.

In your shoes, I would not do this with an emergency fund.  You have traded a little more yield for interest rate risk plus a little default risk.  Laddering some low penalty CD's and some higher yielding savings accounts makes more sense to me.

McStache

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Re: Emergency fund during a downturn
« Reply #17 on: October 19, 2017, 04:27:54 PM »
You could also consider I-bonds as part of your bond allocation/emergency fund.  You'd have to wait 12 months until it was available to draw down from, but it sounds like you could wait a year.  Right now the real rate is 0 (hopefullymaybe going up on 11/1), but it is guaranteed to keep pace with inflation and in the case of a deflationary event your semi-annual composite rate of return will never go below 0.

surfhb

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Re: Emergency fund during a downturn
« Reply #18 on: October 19, 2017, 05:04:57 PM »
2 years worth of cash would be very little compared to one's overall FIRE stash.     2 years worth of EFs sounds smart

EnjoyIt

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Re: Emergency fund during a downturn
« Reply #19 on: October 20, 2017, 01:46:08 PM »
2020..thanks for the link, ill take a look

Gumption, may I give you something different to consider.  You are talking about risk, and the risk of a recession so close to your retirement.  That indeed is some serious risk which may be why your may want to reconsider your asset allocation.  Maybe 80/20 is a bit too high risk for an almost retiree.  Holding extra cash is in effect no different than increasing your asset allocation.  Lets say you are 80/20 and have a networth of 800k.  That means 160k is in bonds.  If you now start to create a 2 year cash reserve on top of that you are in effect increasing your asset allocation past the 20% bonds if you consider cash your "safe" asset class and part of the bond portfolio. I think for potential yearly retirees deciding on bond allocation based on age is inappropriate because that adage is based on a 65 year retirement on not the risk of a 40+ year old early retiree.  Personally if I was looking to retire in the next 2.5-3 years I would have a much higher bond allocation getting to 60/40 or 50/50 on the day I retire and then re-evaluating after/during the next recession. 

Next, in todays low interest rate bond environment, 5 year CDs are an interesting option.  Remember you don't need to hold a 5 year CD for all 5 years.  You can redeem at any time and take a small penalty (usually 6 months interest)  In effect.  For example Ally currently has a 2.25% 5 year CD with a 5 month early withdrawal penalty.  Here is what it looks like if you were to withdraw early:

Effective APY By Year         
1 Year   1.31%            
2 Years   1.79%            
3 Years   1.95%            
4 Years   2.03%            
5 Years   2.25%            

As you can see holding it past 1 year puts you ahead of the 1.2% savings account.  Keep in mind you will not be withdrawing all the funds at once.  It may take you 2-3 years to get all that cash out effectively increasing the interest rate on the money still in there.

My personal plan is to hold 5 years of living expenses in a 5 year CD ladder as part of the bond portion of my asset allocation

Eric

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Re: Emergency fund during a downturn
« Reply #20 on: October 20, 2017, 02:55:08 PM »
2 years worth of cash would be very little compared to one's overall FIRE stash.     2 years worth of EFs sounds smart

~8% sounds like very little?  Definitely disagree with that characterization.  That's a LOT of cash.
"Compound interest is the most powerful force in the universe."  -- Einstein

surfhb

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Re: Emergency fund during a downturn
« Reply #21 on: October 20, 2017, 03:49:28 PM »
2 years worth of cash would be very little compared to one's overall FIRE stash.     2 years worth of EFs sounds smart

~8% sounds like very little?  Definitely disagree with that characterization.  That's a LOT of cash.

It wont be when you lose your job, equity in your home and your investment portfolio loses half its value. 

Everyone is different.   For me, 2 years of a EF would be a small portion of what I would be comfortable with retiring.   
« Last Edit: October 20, 2017, 03:51:50 PM by surfhb »

Eric

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Re: Emergency fund during a downturn
« Reply #22 on: October 20, 2017, 03:55:08 PM »
2 years worth of cash would be very little compared to one's overall FIRE stash.     2 years worth of EFs sounds smart

~8% sounds like very little?  Definitely disagree with that characterization.  That's a LOT of cash.

It wont be when you lose your job, equity in your home and your investment portfolio loses half its value.

I don't think many retired people have jobs.  Or if they lose them, it's probably not a big loss.  We can certainly check to see whether holding a bunch of cash performed well historically.  I'll save you some time and cut right to the point.  It did not.  So while I understand the idea that it's some sort of pacifier to those without jobs, it doesn't actually work.  All it really does is make it MORE likely that your portfolio would fail, which is the exact opposite of its intended purpose.
"Compound interest is the most powerful force in the universe."  -- Einstein

surfhb

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Re: Emergency fund during a downturn
« Reply #23 on: October 20, 2017, 04:12:31 PM »
2 years worth of cash would be very little compared to one's overall FIRE stash.     2 years worth of EFs sounds smart

~8% sounds like very little?  Definitely disagree with that characterization.  That's a LOT of cash.

It wont be when you lose your job, equity in your home and your investment portfolio loses half its value.

I don't think many retired people have jobs.  Or if they lose them, it's probably not a big loss.  We can certainly check to see whether holding a bunch of cash performed well historically.  I'll save you some time and cut right to the point.  It did not.  So while I understand the idea that it's some sort of pacifier to those without jobs, it doesn't actually work.  All it really does is make it MORE likely that your portfolio would fail, which is the exact opposite of its intended purpose.

That's cool 

I'm just going on my own experience.    I lived through both of these recent boom and busts markets and thanked God I had a good Emergency fund.   

VolcanicArts

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Re: Emergency fund during a downturn
« Reply #24 on: October 21, 2017, 12:03:41 AM »
Iíve been contemplating the best way to approach an emergency fund recently. Throughout most of my life, I always had a lot of cash on the sideline just waiting for the unknown to happen. I came to the conclusion that the best scenario for me is to just have a good credit card with about a 30k limit on it and use that for any sudden EF needs that might arise. Yes the interest is high, but it would allow me to survive for a long period of time without having to touch my stache very much, and I could use dividend distributions to pay off the minimum balances monthly and buy myself a lot of time. I figure even in a bad economy, I could land a job in under five months and I could work agency or freelance just to keep money coming in while job hunting. Once I secured another job I would probably be able to pay off the credit card balance rapidly and then I could use it again in another downturn if needed.