Hello Everyone,
Currently figuring out a housing budget and was wondering how you all plan to replenish an emergency or housing fund after you've needed to use it? I assume you are allocating every dollar your earn to some part of your budget whether its to expenses or savings. So if you were to ever need to use money for a big ticket item (house repair, new car, etc.) how would you go on to replace that money? Do you cut your savings back until its filled up or do you cut expenses? Thanks!
That's the paradox of an emergency fund. If you believe an emergency fund is a necessary thing, and you actually use it in an emergency, then the emergency fund
must be re-filled out of your investments. Otherwise you have no emergency fund. Which means you are actually using your investments, not cash, for your emergency fund. Or you could refill it over time, but if you have an emergency before it is re-filled, then that again means you are relying on your investments, not cash, for your emergency fund.
Which means you don't really need a cash emergency fund. What you do need are liquid assets that are sufficient to get you through some future emergency. Those assets can be stocks, and in order to make sure they are sufficient figure in a potential drop of 20-50% in case a market crash coincides with an emergency. Not having a cash emergency fund solves the paradox.
Some people say that cash emergency fund prevents having to sell stocks in an downturn. Two problems with that. 1) How do you fill up the fund again? and 2) it is an extremely expensive form of insurance. Emergencies are rare (which is why they are called emergencies). Stock market crashes are also rare. But if those events do coincide, you probably won't sell off the whole fund in one day. You'll most likely sell stocks over a period of months. And most stock market corrections are measured in months. Remember, the stock market ends on a down year only 5% of the time (1 out of 20 years), on average. So you might have to
sell some at the bottom, but probably not all. And, FWIW, the stock market doubles about every ten years. So if you have an emergency ten years from now, right as there is 50% market correction, AND you have to sell the whole thing at the bottom, you'd likely in the same financial position as if your emergency fund had been in cash the whole time. So the cash emergency fund didn't improve your financial position.
But if you don't have an emergency for 20 years, then you (most likely) will bet in far, far better financial position, and therefore safer financially, than if you kept your e-fund in cash that whole time. So a cash e-fund
increases your financial risk over time compared to not having an e-fund. So the cash e-fund will provide very little downside protection unless the stars align perfectly, and very likely will provide no downside protection at all. That's exactly the opposite of how insurance should work. And course, you give up all of the upside gains.
Re: House fund. That's a little different. When you save up enough to buy the house, then just buy the house and you are done. No need to refill the fund unless you decide to buy another house.