Optimizing "Emergency Fund" size at different stages of FIRE journey

[Financial.Velociraptor]

Want to start a discussion on how much of an EF is needed as someone progresses through the FIRE journey.

When I was getting started, I had a mortgage and a job in the highly cyclical oilfield services sector.  I could be out of work at any time just as most employers in Houston would be cutting back instead of expanding.  A double whammy.  I kept 12 months of expenses in EF.

Seven years later, I had substantially paid down mortgage balance.  When I could extinguish the remainder of my mortgage with half of my EF, I did.  Six months of cash seemed enough to sleep well at night with a paid off house.  Hadn't really thought it through but I could have lowered EF balance sooner.  With right around a 1,000/mo in P&I no longer in the budget, six months of cash was $6k less than before.  Could have paid off the house Six Thousand earlier.

Since quitting the corporate world on 5OCT2012, I have kept only a trivial amount of cash.  I no longer need to have funds to temporarily replace a salary.  I use a  margin loan from Interactive Brokers as an EF if I need a major repair like roof work or HVAC replacement.  Tighten the belt for a few months and extinguish the loan.

Is your current EF sized to reflect where you currently are financially?  How could you optimize?

[norajean]

Emergency funds are primarily for people with out of control finances and lives for whom emergencies are common and consequences are severe without cash saved. Most readers here will never need one.

[Morning Glory]

This is a good question. I never kept much ef because until recently I had a stable job and could just temporarily decrease saving or get a HELOC if I needed cash. Now that I'm approaching my fire date I'm wondering how much cash to keep on hand to avoid selling stock in a bad market. I'm thinking 3-6 months worth of spending maybe?

[Radagast]

I think there are two parts:
1. An appropriate base emergency fund size is the 2nd standard deviation of monthly expenses. In other words, enough to not bother looking at your checking account more than once in 20 months to see if bills are being paid.

2. Add to that the second annual standard deviation of income needed to support cost of living. In other words, your employment situation should only test your ability to eat and not take a penalty for tapping retirement accounts or doing something unpleasant once in 20 years (as best as you can guess).

So you would have wanted about 14 months of expenses in your situation as a sole income earner in a known unstable field. Now you don't need the second part.

We are in a situation with two versatile income earners in in-demand fields and three rentals to cover the mortgage, such that we have no realistic prospect of needing to tap retirement accounts or do something unpleasant in case of a job loss. So I keep enough to look at the checking account with concern about every two years (just happened... we blew $12,000+ in three months!).

I have been trying to define that one for a while, finally spat it out.

[Dicey]

We have more money in cash than we ever dreamed of having. We don't call it an EF any more. We call it a "Glide Path."

We're also on the hunt for another RE project, so it has a second title: "Dry Powder".

I'm sure that's not helpful, but that's where we are in our post-FI/RE journey, and you did ask ;-)

[SpareChange]

Emergency funds are primarily for people with out of control finances and lives for whom emergencies are common and consequences are severe without cash saved. Most readers here will never need one.

Yeah, this.

[4tify]

When I started out my goal was to have 9-12 mo worth of expenses, but I was also a freelancer so long periods of unemployment were very possible. I think that totaled about $36k, but I never got close to using it.

I always kept that in cash as I made the climb to FI. Now that I’m close to RE I’ve slowly increased it to 2+ yrs to account for SORR once I pull the trigger. That said, based on the way I’ve conducted myself I’d be surprised if I ever use it. Who knows. It gives me a sense of security even though it’s probably totally unnecessary.

Like @Dicey i can alway deploy it for some random adventure :)

[Metalcat]

EFs are entirely personal and depend on a lot of factors beyond what your savings level is.

[Metta]

We have more money in cash than we ever dreamed of having. We don't call it an EF any more. We call it a "Glide Path."

We're also on the hunt for another RE project, so it has a second title: "Dry Powder".

I'm sure that's not helpful, but that's where we are in our post-FI/RE journey, and you did ask ;-)

This is basically us as well. Though our dry powder is for opportunities in the stock market.

[ender]

Emergency funds are primarily for people with out of control finances and lives for whom emergencies are common and consequences are severe without cash saved. Most readers here will never need one.

This seems pretty naive to me.

[Metalcat]

Emergency funds are primarily for people with out of control finances and lives for whom emergencies are common and consequences are severe without cash saved. Most readers here will never need one.

This seems pretty naive to me.

Yeah, and it makes absolutely no sense.

Everyone has unexpected expenses. No matter what, you have to divert cash from somewhere to cover an unexpected expense. Having an EF just allows you to have a reserved fund from which to divert funds as opposed to diverting them from normal spending or from investments.

It's insane to think that the average person will never face a circumstance where they need access to more money than they usually spend in a month.

[Dicey]

We have more money in cash than we ever dreamed of having. We don't call it an EF any more. We call it a "Glide Path."

We're also on the hunt for another RE project, so it has a second title: "Dry Powder".

I'm sure that's not helpful, but that's where we are in our post-FI/RE journey, and you did ask ;-)

This is basically us as well. Though our dry powder is for opportunities in the stock market.

Yup, our Dry Powder is the Fast-Acting, All Purpose stuff.

[vand]

It's a good question.

I think the value of an EF is, moreso than actually providing a financial buffer, for many people it is the first time and first step in disciplining yourself to live on less than you earn and creating a surplus every month. For many DR follower types, this is a big change in mindset.

Yes the EF is actually useful every now and again when you need to access the money, but really it plays the more important role of creating the wealthbuilding mindset without having the extra layer of faff (or excuse) of not knowing what to invest in.

I'd argue that if your natural inclination is that you have always been a thrifty and always been a saver-type of person, then the value of a sizeable EF is actually pretty small.

[SotI]

I keep about 1.5 x annual expense in cash or savings accounts.
Some of it is EF (some house repair or other unplanned cashout), but mostly it's due not really having found an alternative to my bonds part of my investment strategy yet.

My portfolio strategy considers liquidity and bonds closely related. It's also dry powder for stock market down turns. I plan to retire in 8 years, so I don't really want to go in full equity at this stage, anymore. It's a personal comfort zone thing.

[GuitarStv]

Emergency funds are primarily for people with out of control finances and lives for whom emergencies are common and consequences are severe without cash saved. Most readers here will never need one.

This seems pretty naive to me.

Yeah, and it makes absolutely no sense.

Everyone has unexpected expenses. No matter what, you have to divert cash from somewhere to cover an unexpected expense. Having an EF just allows you to have a reserved fund from which to divert funds as opposed to diverting them from normal spending or from investments.

It's insane to think that the average person will never face a circumstance where they need access to more money than they usually spend in a month.

I've never needed to keep an emergency fund (although I did for a while until figuring this out).

If an unexpected expense comes up, I'll sell some bonds or mutual funds to pay it.  Keeping money separate in cash, not working for you makes no sense.

[secondcor521]

While working, I kept a 4 months of expenses in my emergency fund.

I was going to say I'm 52 and never had to use my emergency fund because I lead a very boring life.  However, I did eventually remember that I did lose a job unexpectedly once, and I don't recall the details except that I must have been living off savings until I got my next job.  I also had a job once where they were paying me 100% in private company stock, so I was living off savings at that point as well.  Both situations lasted about 3 months (which is, in part, how I arrived at my "4 months of expenses" EF size mentioned above).

Now that I am FIREd, I don't keep one.  I refill my bank accounts with periodic sales from taxable; if something unexpected and expensive came up, I'd just sell more from taxable.  I don't worry about SORR because my net WR is about 1%.  I obviously don't worry about job loss any more.  For medical and liability issues I have insurance.  My car is well maintained but I suppose it could die unexpectedly.  It hasn't yet but if so I would probably pay to have it repaired.  I really can't think of any thing that would be large, unexpected, urgent, and not covered by insurance.  I guess I have a poor imagination.  Also, in general I lead a boring life.

[Metalcat]

Emergency funds are primarily for people with out of control finances and lives for whom emergencies are common and consequences are severe without cash saved. Most readers here will never need one.

This seems pretty naive to me.

Yeah, and it makes absolutely no sense.

Everyone has unexpected expenses. No matter what, you have to divert cash from somewhere to cover an unexpected expense. Having an EF just allows you to have a reserved fund from which to divert funds as opposed to diverting them from normal spending or from investments.

It's insane to think that the average person will never face a circumstance where they need access to more money than they usually spend in a month.

I've never needed to keep an emergency fund (although I did for a while until figuring this out).

If an unexpected expense comes up, I'll sell some bonds or mutual funds to pay it.  Keeping money separate in cash, not working for you makes no sense.

That's why I said it's entirely personal. But the money has to come from somewhere and for some people it makes sense to keep it in an emergency fund.

Never did I say that everyone needs an EF, I don't have one.

[Dicey]

I seem to recall at least one thread that asked people when they'd needed to use their emergency funds. Maybe @RMD can work some search magic to find it. It was pretty interesting.

@secondcor521, perhaps the details are fuzzy is because you wisely had funds available, saving you from hair on fire panic that you'd remember ;-)

[Telecaster]

My "emergency" fund is about month's expenses in cash.  I may have told this story before, so forgive me if you've heard it.   Common financial advice is to raise the deductibles on your insurance.  So back in the day I did that and then it sort of came to me that if you are going to self-insure like that you actually have to self-insure.  So I set up a savings account and put the difference in there on automatic deposit.   After a while my insurance account got to be larger than my deductible by 20% or something.  Then I realized I could simply invest the whole thing and in the event of a market drop (most market drops anyway) I'd could still pay the deductibles.  So I invested my insurance fund. 

Then I gradually came to the conclusion that the biggest safety net was simply having lots of money, and holding lots of cash doesn't help with that so I invested all of my emergency fund.  Now those monies are at multiples of their original value.  Even if there was some horrific market drop tomorrow combined with an emergency I'm in a vastly better financial position having invested those monies.

I understand the logic as to why emergency funds (usually expressed as X month's expenses in cash) are recommended to new investors.  But I think most people would be better off just investing as soon as they have enough cash on hand to handle normal month expense fluctuations.  If you have a true emergency (the water heater going out isn't an emergency) you can always just tap your investment account.   In the early going, there is a slight risk of losing money but there are worse things than losing money. 

[ChpBstrd]

A relative who worked at a local bank told me stories of people who would keep $250,000 or $500,000 in CDs earning nearly nothing. I had more questions. Turns out they were middle class people who didn’t trust the stock market and didn’t know enough to invest in bonds. However, if they really did need immediate cancer treatment or a transplant or whatever, they’d still have to pay a penalty to access their money, and it might not be quick.

As long as you’re not doing that, you have my permission to keep $20k or so in cash or short term bond ETFs.

[PDXTabs]

I currently have a cash EF, but I plan to move to the Telecaster method in the future.

[Eco_eco]

For a long time I maintained an untapped line of credit as an emergency fund. Eventually I realised that if an emergency came along that required using debt it would probably add to my stress at that time, not resolve it.

After a certain point of savings it’s all just an asset allocation problem (ie how much to hold in cash), so I decided a little while back to switch to a mini fund approach.

I split out some of our weekly savings into a fund which would cover our annual family cell phone costs, at a 3% yield. This is about 50% built now and when its fully charged it will give us regular income to cover the cost of replacement phones every four years and monthly line costs. If an emergency comes along which needs a lot of cash I won’t worry about liquidating this fund - we can always make the phones last a year or two longer - but then I won’t feel like I’m dipping into our main pool of assets.

I also like having a small savings goal to focus on when our regular savings no longer meaningfully move the needle.

[vand]

A perfectly rational way to think about cash is that its role is not to enhance return, or even enhance risk-adjusted return.

It's role is to promote optimal investor behaviour, whatever else is in your portfolio.

So, you hold as much cash as you need to sleep well at night. Of course, this touches on the whole subject of asset allocation.

This is why I don't have a problem at all with the DR type advice to build a big EF first - it's aim is to put in place the foundations for a lifetime of optimal behaviour, so who cares if it delays your wealth building journey by a couple of months. 

Yes, I have heard stories of rich folk who keep $20k in a home safe. Fine, that's a level of security that they can afford, and if it's 0.001% of your wealth then it really doesn't matter.

[FLBiker]

I really appreciate the different approaches here to thinking about an emergency fund.

Historically, we always had a very small emergency fund (maybe a couple of months).  At that time, we both had very stable jobs and a high savings rate, so it was easy to very quickly save up for something like a roof or HVAC or whatever, and we had no fear of losing our jobs.  Last year, my wife quit her job and I changed mine, plus we moved from the US to Canada.  We are also quite close to (if not at) our FI number.  We currently have a much bigger emergency fund (~18 months).  I am investing some of it, but we've kept it bigger for a couple of reasons.  Number one, we weren't sure what was going to happen with our jobs.  DW is starting to work part-time, and my job seems stable enough, so I think we can back off a bit.  Also, we wanted to have a cash cushion in both currencies to avoid having to exchange when the rate was unfavorable.  Starting next month, I'll be paid in Canadian dollars, so that will help there as well.  Since we're closing in on FI, though, I still think we'll keep more cash than previously, just so we wouldn't have to sell equities when things are down.

For us, I think about it less as an emergency fund and more as part of our non-equity portion of our portfolio.  We're about 85% stock, 15% bond and cash.  As our cash position has grown, I've let our bond position shrink (by not rebalancing into it).

[pasadenafr]

It's role is to promote optimal investor behaviour, whatever else is in your portfolio.

So, you hold as much cash as you need to sleep well at night.

This is me. In 2019, I had reduced my EF from 6 months of expenses to a little more than one. Then the COVID crash came, with all the uncertainty about the economy that came with it, and I got scared of losing my job and being unable to find a new one anytime soon (think, 2008). Too many unknowns. I *knew* I had enough money in my brokerage account to live on for 2-3 years without touching my Roth. But the idea of made me sick - that's my FIRE money, FFS. Mental accounting is a powerful thing :)

So I rebuilt my EF back up to 6 months of expenses. I didn't need financial anxiety on top of the virus fears.

Now, what if I were FIRED and didn't need income replacement? I'm not sure. I'd probably keep some cash aside, but not as much as I do now. That said, I'd also have a more conservative AA, so there's that.