Author Topic: Explain to me why a cash emergency fund makes sense  (Read 1692 times)

lutorm

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Explain to me why a cash emergency fund makes sense
« on: February 24, 2020, 01:15:13 PM »
So I'm confused about something: Everyone seems to agree that some sort of emergency fund kept in a savings account is useful. Why is this?

Here's how it seems to me: I fully agree that you need some means of easily accessible funds to cover expenses that may come up, but I assume that everyone here has credit cards with substantial credit lines that they can tap should such an event occur. This would give ample time to liquidate enough investments to pay off the card before the billing cycle is up.

But people seem to think that needing to liquidate investments on short notice is a bad thing. Why? That just seems like a special form of the market timing argument to me. If the market on average yields better than a savings account, having a short term fund in cash loses out on this, because on average you would have gotten a better yield putting the funds into investments than the interest on the card. Yes, it's true that you might have to liquidate right after a big drop (like today?) but it's more likely you're just missing out on market returns. Over the long run we're playing averages here and I don't see how a savings account can come out on top.

habaneroNorway

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Re: Explain to me why a cash emergency fund makes sense
« Reply #1 on: February 24, 2020, 01:26:46 PM »
Why own bonds at all when on average and over time equities are expected to provide much higher returns? You can flip your argument around and conclude that 100% equities is the only AA that makes any sense. After all, if you need some money, just sell some.

utaca

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Re: Explain to me why a cash emergency fund makes sense
« Reply #2 on: February 24, 2020, 01:27:18 PM »
I think of my fairly substantial savings account as insurance against making a bad decision the next time the market tanks. I understand that rationally it would almost certainly be better to have my savings invested. Unfortunately, I'm a human not a robot so I need to factor that into my investment plan. 

ixtap

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Re: Explain to me why a cash emergency fund makes sense
« Reply #3 on: February 24, 2020, 01:38:39 PM »
The main cited reason for an EF measured in months' expenses is largely for job loss. In case of job loss, you could also loose access to credit. Lay offs are more likely to happen when the market is down, rather than up.

Even if the market is up, you are likely incurring capital gains tax that will mitigate the gains you have made.

In our case, we keep cash for a variety of reasons, but none of them are particularly financial. I keep a HYS in my name out of habit and in case anything happens to DH and it takes a couple of months to access his funds. He keeps a HYS in his name out of habit and because he front loads all the workplace savings programs and so only gets a significant paycheck for a few months of the year. We use his HYS to even out the cash flow.

The true irony of EF in cash is that you most need to have it when it is a large percentage of your portfolio. As your portfolio grows, it becomes less important. But the same amount of cash is such a tiny percentage of your portfolio that moving it around isn't going to make a significant difference in the performance of your portfolio. I have slightly more cash now than when I was gathering my resources to make a down payment on a condo low those many years ago, but now it is a miniscule portion of the overall portfolio. And it is likely the same or less if we adjusted for inflation.

DadJokes

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Re: Explain to me why a cash emergency fund makes sense
« Reply #4 on: February 24, 2020, 01:49:22 PM »
The best answer is risk tolerance. If you don't mind selling at a time when the market has just lost a fair bit, then keep your "emergency fund" in the market. You will probably be better off mathematically.

However, some people sleep better at night with a small chunk of money that either keeps up with or even earns less than the inflation rate that will be easily available.

Malkynn

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Re: Explain to me why a cash emergency fund makes sense
« Reply #5 on: February 24, 2020, 02:03:14 PM »
There have been several threads on the matter, and not everyone agrees on cash emergency funds, and even those who do have them, there's definitely no consensus on amount.

DH and I have no cash emergency fund, we have nearly two years of expenses available in low interest LOC.

nereo

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Re: Explain to me why a cash emergency fund makes sense
« Reply #6 on: February 24, 2020, 02:49:15 PM »

But people seem to think that needing to liquidate investments on short notice is a bad thing. Why? That just seems like a special form of the market timing argument to me. If the market on average yields better than a savings account, having a short term fund in cash loses out on this, because on average you would have gotten a better yield putting the funds into investments than the interest on the card. Yes, it's true that you might have to liquidate right after a big drop (like today?) but it's more likely you're just missing out on market returns. Over the long run we're playing averages here and I don't see how a savings account can come out on top.

Others have addressed the holding cash part. 
To specifically address needing to liquidate investments on short notice (as your source of an EFund) - the fear/risk is that you will need that money precisely when there has been a market downturn.  Remember that layoffs are correlated to market downturns, and perhaps the most likely time you will need emergency cash is precisely when you would be selling at a loss.
A second consideration is taxes.  Whereas cash on hand has no taxable burden, cashing out equities could require an additional 15% (or more) in taxes.

Echo ixtap that - as your total assets increase your need for an EFund decreases.  Also echo others that there are other ways of having an efund... LOC, equities (with the acknowledgement that you may sell at a loss and incur a stiff tax penalty), bonds, etc. None are perfect - cash on hand loses out to inflation. LOC can be closed (especially after a job loss or when the economy takes a dive). Bonds need to be laddered properly or you might lose out by selling before maturity.

Currently we keep ~2 months cash on hand, and will rely on selling shares and/or tapping our LOC depending on the situation. YMMV.

lutorm

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Re: Explain to me why a cash emergency fund makes sense
« Reply #7 on: February 24, 2020, 03:36:02 PM »
Thanks everyone for the responses.

A second consideration is taxes.  Whereas cash on hand has no taxable burden, cashing out equities could require an additional 15% (or more) in taxes.
I wanted to address this directly, because it seems like a clear fallacy to me: You don't pay (much) taxes on a savings account, because it doesn't give you much of a return. It's the same on your investments, if they haven't appreciated. But avoiding gains because you don't want to pay 15% tax on them seems completely backwards.

PDXTabs

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Re: Explain to me why a cash emergency fund makes sense
« Reply #8 on: February 24, 2020, 03:51:22 PM »
But avoiding gains because you don't want to pay 15% tax on them seems completely backwards.

Especially since long term capital gains are taxed at a lower rate than interest (at least in the USA).

nereo

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Re: Explain to me why a cash emergency fund makes sense
« Reply #9 on: February 24, 2020, 03:58:01 PM »
Thanks everyone for the responses.

A second consideration is taxes.  Whereas cash on hand has no taxable burden, cashing out equities could require an additional 15% (or more) in taxes.
I wanted to address this directly, because it seems like a clear fallacy to me: You don't pay (much) taxes on a savings account, because it doesn't give you much of a return. It's the same on your investments, if they haven't appreciated. But avoiding gains because you don't want to pay 15% tax on them seems completely backwards.

It’s nota fallacy. But one of the considerations one has to make.
As an example, imagine you earn >$78k but need to access $10k for an emergency. If you rely on you equities you will pay 15% on gains, which could be an extra $500-1,000 depending on your LTCG.
Those same shares might have been earmarked to be used after retirement, at a LTCG of 0%.

That tax penalty offsets the opportunity cost of having a “cash drag” of an efund held in a MMA

PDXTabs

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Re: Explain to me why a cash emergency fund makes sense
« Reply #10 on: February 24, 2020, 04:41:53 PM »
As an example, imagine you earn >$78k but need to access $10k for an emergency. If you rely on you equities you will pay 15% on gains, which could be an extra $500-1,000 depending on your LTCG.
Those same shares might have been earmarked to be used after retirement, at a LTCG of 0%.

That tax penalty offsets the opportunity cost of having a “cash drag” of an efund held in a MMA

But if I'm paying ~$1K in LTCG I sold $10K worth of stock that I paid ~$3500 for. If I use cash I had to actually save $10K.

nereo

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Re: Explain to me why a cash emergency fund makes sense
« Reply #11 on: February 24, 2020, 04:58:33 PM »
As an example, imagine you earn >$78k but need to access $10k for an emergency. If you rely on you equities you will pay 15% on gains, which could be an extra $500-1,000 depending on your LTCG.
Those same shares might have been earmarked to be used after retirement, at a LTCG of 0%.

That tax penalty offsets the opportunity cost of having a “cash drag” of an efund held in a MMA

But if I'm paying ~$1K in LTCG I sold $10K worth of stock that I paid ~$3500 for. If I use cash I had to actually save $10K.
Correct, but in all likelihood you would have more than just that amount of principle.
I’m not saying it makes keeping cash superior. Just that selling stocks May result in a tax hit exactly at a time when one is cash-flow negative.


Villanelle

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Re: Explain to me why a cash emergency fund makes sense
« Reply #12 on: February 24, 2020, 05:19:55 PM »
The only cash EF I have is what accumulates in our checking account before a come along every few months and scrape out the extra for investing.  That and the account into which our rent check is deposited before I clean that out periodically. (They couldn't use our main bank, so it goes into the checking account I've had since I was 18, which is used for nothing else.)  That's another thing I only do every few months so it often piles up.

IOW, due to laziness, I might have several months of expenses (or more) at a certain moment.  Otherwise, it's cash flowing, credit, selling equities, and an equity line that's probably 1/4 or less of our actual equity but more than a year's worth of expenses.

Of all the many things over which I lose sleep, this is not one.  Not one second. 

Telecaster

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Re: Explain to me why a cash emergency fund makes sense
« Reply #13 on: February 24, 2020, 05:22:00 PM »
It’s nota fallacy. But one of the considerations one has to make.
As an example, imagine you earn >$78k but need to access $10k for an emergency. If you rely on you equities you will pay 15% on gains, which could be an extra $500-1,000 depending on your LTCG.
Those same shares might have been earmarked to be used after retirement, at a LTCG of 0%.

That tax penalty offsets the opportunity cost of having a “cash drag” of an efund held in a MMA

I just saw PDXTabs post, but I was going to say almost the same thing, so I will :).    You only pay LTCG if you had a gain.   $1,000 in LTCG taxes implies a gain of $6500.   That's $6500 more than you would have had by keeping the money in an MMA (pretty close).  The gain completely swamps out the tax penalty.     

It is generally considered wise to have a certain amount of ready cash, as well as portion of your portfolio in bonds, of course. And people always say they don't want to sell into a down market.  Which I fully understand. But if you have a large cash emergency fund, you are essentially giving up that $6500. 

I'm not trying to change anyone's mind.   Whatever helps you sleep the most soundly at night is best.  But people tend to confuse themselves when putting money in different buckets.  It is all one bucket. 






Buffaloski Boris

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Re: Explain to me why a cash emergency fund makes sense
« Reply #14 on: February 24, 2020, 05:23:53 PM »
Well, not everyone agrees that a EF is necessary or the form that it should take. This is a tough one for me, and we've had an emergency fund for a long time.  And here are the number of times over many years we've tapped it; -0-

I'm moving over to the dark side on this question.  You can pull contributions (not earnings!) from a Roth IRA tax free at any time.  Many employers allow loans from your 401(k).  You probably have credit cards.  A HELOC is a possibility.  I'm not seeing much point these days in allowing a significant chunk of money sit in a 0.05% interest rate savings account. YMMV. 

rudged

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Re: Explain to me why a cash emergency fund makes sense
« Reply #15 on: February 24, 2020, 05:36:50 PM »
In his online video on emergency funds, MMM makes the point that those of us in the FIRE movement who are in the process of becoming financially independent are presumably saving a great deal of our income. So if an unexpected emergency arises (assuming it is not huge), you could address it by simply reducing your rate of savings.

This may be a satisfactory answer for someone on the way to financial independence, but to my mind it just postpones the problem. Once you reach financial independence and retire, you presumably won't be saving a lot, and as such, the question of whether you should have an emergency fund and how large it should be comes back with a vengeance.

PDXTabs

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Re: Explain to me why a cash emergency fund makes sense
« Reply #16 on: February 24, 2020, 05:41:10 PM »
FWIW I'm not actually opposed to a cash emergency fund and actually quite like I series savings bonds.

moof

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Re: Explain to me why a cash emergency fund makes sense
« Reply #17 on: February 24, 2020, 05:43:13 PM »
The need for an emergency fund is positively correlated with market downturns.

If you live nearly paycheck to paycheck the following scenario is not uncommon:
1)  Recession, markets tanks 10-40%.
2)  You get laid off since your company has to cut costs to weather the storm.  You now have about 0-2 months of assets from your severance (if any).
3)  You are now unemployed and can't get a loan or expand your credit card limit.
4)  Any bad stuff is extraordinarily stressful and can result in long term financial damage.

Having a cash reserve of 2-6 months buys you time and options before you are out on the street or have to start selling off 401k assets at the bottom with penalties.

If you are a good saver you'll have a taxable account in all likelihood, and also some Roth principal that can be accessed without penalty.  Congratulations, you are not the ones that the advice is aimed at.  Having 4-7 figures in the bank puts you in an entirely different league than most folks in this country.  Positive net worth is the norm on this site, not in the country as a whole.

If you can weather a broken furnace, totaled car, or other similar life even without breaking a sweat or freaking out about selling a small portion of your assets at the bottom to fund it, congratulations, you don't need an emergency fund.
« Last Edit: February 24, 2020, 05:45:07 PM by moof »

Telecaster

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Re: Explain to me why a cash emergency fund makes sense
« Reply #18 on: February 24, 2020, 06:03:14 PM »
This may be a satisfactory answer for someone on the way to financial independence, but to my mind it just postpones the problem. Once you reach financial independence and retire, you presumably won't be saving a lot, and as such, the question of whether you should have an emergency fund and how large it should be comes back with a vengeance.

Problem solved: The 4% rule.  I mean, there could be some large unanticipated financial problem, but the EF doesn't actually help with that.  First though, the issue of a job loss at the same time as a stock market downturn goes away.  Now, let's say we are planning for some large unanticipated financial problem, how big should the EF be?  If you think you'll need more than your annual WR in that event, then lower your WR to 3.8% or whatever you feel comfortable with so that 0.2% (or whatever) is sitting there waiting for an emergency.    But all you are really doing is retiring with a bigger amount of money.    And now lets say the emergency is over and the EF is depleted.   Now what do you do?  Do you simply not have a EF for the rest of your retirement?   Or do you replenish the fund out of the rest of your portfolio?  If it is the latter, then you never actually had an EF.

That's why I say people get confused by trying to put money in buckets.  It is really all just one bucket.  If you want more safety that a 4% WR provides, then retire with more money.   








use2betrix

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Re: Explain to me why a cash emergency fund makes sense
« Reply #19 on: February 24, 2020, 06:38:38 PM »
If I want to say FU at work and take a 6-12 month sabbatical, I don’t want the current market state to have anything to do with whether or not I can leave. If a market is in a recession/big downturn, I’m not going to want to pull a years worth of living expenses out of it.

If the market did crash hard/hit a recession, I would start dumping my emergency fund into it. I would also be less likely to take an “unplanned” sabbatical during a market downturn so that I can keep investing.

American GenX

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Re: Explain to me why a cash emergency fund makes sense
« Reply #20 on: February 24, 2020, 06:44:25 PM »
I've never heard of any consensus that everyone should have an emergency fund, let alone that it should be a savings account.

I never felt a need to designate any funds as "emergency".  My stash is well diversified, and there's always funds I can get to quickly if needed.  I do not have anything that I specifically refer to as an emergency fund.

use2betrix

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Re: Explain to me why a cash emergency fund makes sense
« Reply #21 on: February 24, 2020, 06:49:00 PM »
I've never heard of any consensus that everyone should have an emergency fund, let alone that it should be a savings account.

I never felt a need to designate any funds as "emergency".  My stash is well diversified, and there's always funds I can get to quickly if needed.  I do not have anything that I specifically refer to as an emergency fund.

I suppose “emergency fund” is just a nickname.. To me it’s no different than “F U stache” or whatever else you want to call it.. Mine could be a car replacement fund, medical emergency fund, lost job fund, whatever..

DeniseNJ

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Re: Explain to me why a cash emergency fund makes sense
« Reply #22 on: February 24, 2020, 07:21:24 PM »
Quote
If you can weather a broken furnace, totaled car, or other similar life even without breaking a sweat or freaking out about selling a small portion of your assets at the bottom to fund it, congratulations, you don't need an emergency fund.

So you're talking about an EF of like a grand or so. Not really an Ef, more like just what's left in your acct so checks don't bounce.

I always felt bad that we didn't have a EF. I just save like mad, pay the bills and spend the little bit left until payday. I feel better after reading these posts though. In the event of an emergency I would just have to save a bit less next month 

PoutineLover

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Re: Explain to me why a cash emergency fund makes sense
« Reply #23 on: February 24, 2020, 08:32:04 PM »
I keep some cash (max a few thousand) in savings making about 2-3% generally. I dip into that if something unexpected comes up. I also have access to lines of credit or credit cards, but I wouldn't like to have to pay interest, that's just so I can pay the expense quickly. For those who don't earn tons of money, it's not always an option to just redirect monthly savings, depending on how much the emergency costs. My investments are meant to be long term, so I don't plan to dip into them for anything short of a catastrophic emergency.

SimpleCycle

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Re: Explain to me why a cash emergency fund makes sense
« Reply #24 on: February 24, 2020, 08:53:33 PM »
Cash is part of our asset allocation.  It's not an e-fund per se, but its purpose is to keep us from having to sell investments without a really good reason, and to lessen volatility.  Our AA is also more conservative than the average mustachian, because we both had assets in 2008 and know our own risk tolerance and what a 50% drawdown feels like.  Since we own bonds, the tradeoff is not stock returns vs. cash returns, it's bond returns vs. cash returns.

From a pure "I want to chase maximum returns" standpoint, no cash allocation, 100% U.S. equities, and relying on credit in an emergency is optimal.  Plenty of people can afford to take that risk and want to.  I prefer diversification and a more moderate approach for myself.

lutorm

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Re: Explain to me why a cash emergency fund makes sense
« Reply #25 on: February 24, 2020, 11:06:16 PM »
Why own bonds at all when on average and over time equities are expected to provide much higher returns? You can flip your argument around and conclude that 100% equities is the only AA that makes any sense. After all, if you need some money, just sell some.
I don't think this is actually the same thing, because isn't the argument for a non-100% equity AA is that it can actually increase your long-term return due to rebalancing (while also reducing volatility.)


Michael in ABQ

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Re: Explain to me why a cash emergency fund makes sense
« Reply #26 on: February 25, 2020, 12:32:24 AM »
If there is a power/communication outage due to a natural disaster or some other cause, you will not be able to access credit cards, debit cards, etc. That is one argument for maintaining some amount of physical cash on hand, say $500 to $1,000.

For me, having a couple month's expenses in a high-yield savings account instead of invested in equities is for peace of mind. In the long run that 2-3% per year will basically keep up with inflation and I will lose the earnings potential of that money. However, knowing that I have say $10k set aside if some emergency came up is an insurance policy. If I had to sell $10k in stocks, especially in a down market or from a tax-advantaged account, or charge it on a credit card, that would be just another source of stress. And if I was having to use an emergency fund, it probably means I've got some bigger problems to deal with.

chevy1956

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Re: Explain to me why a cash emergency fund makes sense
« Reply #27 on: February 25, 2020, 12:41:27 AM »
If we are talking about having cash in a safe at home I don't agree with that. If we are talking about having savings in a savings account then I think it's a good idea in certain situations. I don't think it makes any sense if you have a job and have some safety in your job. I'd invest all that money.

If though you are close to retirement or retired maybe a cash fund is there to give you some safety over the next whatever time period as you spend that money or intend to spend it. I for instance intend to retire with close to a years spending in cash and close to 5 years spending in bonds. I will then spend the cash and bonds down.

Car Jack

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Re: Explain to me why a cash emergency fund makes sense
« Reply #28 on: February 25, 2020, 05:31:40 AM »
Having the availability to get cash during an emergency is indeed important.  It does not have to be all cash, CD, high yield savings account.  You can have US Savings Bonds.  I have hundreds of thousands of dollars in paper iBonds and can go to my local credit union and easily cash them.  The funds are immediately available....no hold.

Here's why credit cards are NOT emergency fund.  If you lose your job, the credit agencies will post this.  Many credit cards pay for information on credit reports.  Don't believe it?  I sell tradelines (thanks arebelspy) and I notice I get mail constantly for AU names at my address.  Everything from collection agencies through SOFI refinance offers to AMEX and Cap One offers.  So why's this bad?  Well, that credit card that you're depending on to ride through an emergency can be cancelled.  Then what do you do?

DadJokes

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Re: Explain to me why a cash emergency fund makes sense
« Reply #29 on: February 25, 2020, 05:45:34 AM »
Having the availability to get cash during an emergency is indeed important.  It does not have to be all cash, CD, high yield savings account.  You can have US Savings Bonds.  I have hundreds of thousands of dollars in paper iBonds and can go to my local credit union and easily cash them.  The funds are immediately available....no hold.

Here's why credit cards are NOT emergency fund.  If you lose your job, the credit agencies will post this.  Many credit cards pay for information on credit reports.  Don't believe it?  I sell tradelines (thanks arebelspy) and I notice I get mail constantly for AU names at my address.  Everything from collection agencies through SOFI refinance offers to AMEX and Cap One offers.  So why's this bad?  Well, that credit card that you're depending on to ride through an emergency can be cancelled.  Then what do you do?

Credit cards may only be one option for an emergency fund. Always have contingencies.

Here's our overall emergency mitigation plan:

1. Live on one income (ideally the lower of the two spouses, but we aren't there yet)
2. Stable government jobs, so it's highly unlikely that either of us would be let go, let alone both (also means great health insurance)
3. Enough cash in bank for 1 month
4. Credit cards for emergencies that can be cash flowed within a month
5. Use bank churning money
6. Withdraw current year Roth contributions, which can be replenished
7. Withdraw prior year Roth contributions
8. Reimburse HSA funds that are available
9. Good family network

We don't make enough that we actually have taxable brokerages, but that would be a step if we did. Also, I would assume that many people are also willing to use a HELOC, if available.

Malkynn

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Re: Explain to me why a cash emergency fund makes sense
« Reply #30 on: February 25, 2020, 06:01:45 AM »
Having the availability to get cash during an emergency is indeed important.  It does not have to be all cash, CD, high yield savings account.  You can have US Savings Bonds.  I have hundreds of thousands of dollars in paper iBonds and can go to my local credit union and easily cash them.  The funds are immediately available....no hold.

Here's why credit cards are NOT emergency fund.  If you lose your job, the credit agencies will post this.  Many credit cards pay for information on credit reports.  Don't believe it?  I sell tradelines (thanks arebelspy) and I notice I get mail constantly for AU names at my address.  Everything from collection agencies through SOFI refinance offers to AMEX and Cap One offers.  So why's this bad?  Well, that credit card that you're depending on to ride through an emergency can be cancelled.  Then what do you do?

Well...they *are* actually an emergency fund, they're just an emergency fund that carries a certain degree of risk.

Each option carries a risk and each option needs to be assessed for those risks. This is why there is no correct answer, there's just the answer for the individual that fits their particular risk tolerance.

bigblock440

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Re: Explain to me why a cash emergency fund makes sense
« Reply #31 on: February 25, 2020, 06:22:59 AM »
Having the availability to get cash during an emergency is indeed important.  It does not have to be all cash, CD, high yield savings account.  ...snip.... Well, that credit card that you're depending on to ride through an emergency can be cancelled.  Then what do you do?

Sell equities.  How do you get cash out of a CD?  Isn't there a penalty for that?

rudged

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Re: Explain to me why a cash emergency fund makes sense
« Reply #32 on: February 25, 2020, 08:18:14 AM »
This may be a satisfactory answer for someone on the way to financial independence, but to my mind it just postpones the problem. Once you reach financial independence and retire, you presumably won't be saving a lot, and as such, the question of whether you should have an emergency fund and how large it should be comes back with a vengeance.

Problem solved: The 4% rule.  I mean, there could be some large unanticipated financial problem, but the EF doesn't actually help with that.  First though, the issue of a job loss at the same time as a stock market downturn goes away.  Now, let's say we are planning for some large unanticipated financial problem, how big should the EF be?  If you think you'll need more than your annual WR in that event, then lower your WR to 3.8% or whatever you feel comfortable with so that 0.2% (or whatever) is sitting there waiting for an emergency.    But all you are really doing is retiring with a bigger amount of money.    And now lets say the emergency is over and the EF is depleted.   Now what do you do?  Do you simply not have a EF for the rest of your retirement?   Or do you replenish the fund out of the rest of your portfolio?  If it is the latter, then you never actually had an EF.

That's why I say people get confused by trying to put money in buckets.  It is really all just one bucket.  If you want more safety that a 4% WR provides, then retire with more money.

Thanks! This makes sense.