Cash/Emergency Fund and Taxable/Non-taxable accounts

[Figuring It Out]

I'm in the midst of reading Craig's new book, which is VERY well-written and I suspect will be around as long as HB's books, and I have a question:

My PP will be about 20% taxable and 50% tax-deferred and 30% tax-free (Roth). Should the 20% taxable be part of my cash allocation, seeing as it's also my emergency fund? I'm thinking yes -- some of, anyway, will HAVE to be. But what about the remainder? Taxable, then Roth, which can also be accessed if absolutely necessary. I kind of prefer to put whatever's "hot" in the Roth (ie not cash), because I'd like that larger than my tax-deferred accounts for obvious future tax reasons. In that case, taxable, then tax-deferred seems to be a good approach.

Feedback, please?

[rhymenocerous]

The split of my portfolio across taxable, tax-deferred and tax free accounts is dictated by my most restrictive account: the 401k.  My only suitable choices in my 401k are an S&P500 fund and a money market fund.  Therefore, I place stocks and the majority of my cash in the 401k.  LTTs then go in my Roth, and that leaves gold for taxable.  I do also keep enough cash in my bank account to cover a few months worth of expenses.

If you do not face similar restrictions, I don't see a problem with placing cash in your taxable account given the incredibly low yields.  Note that it wasn't always this way though, so if interest rates ever do start to increase, it would be better to move cash into tax-sheltered accounts and use gold, which pays no interest or dividends, in taxable.

[TripleB]

The percentages don't mean much without nominal figures of your net worth and expenses to back it up, but obviously you want to keep some sort of privacy.

My take would be to have 6 months worth of money "readily accessible" for emergencies. Here's how I'd break it up:

1 months living expenses in physical paper currency that's around your house. For most people this would be $1500 to $3000 which isn't "crazy" to keep in paper cash, and in the event of a short term issue (maybe not a disaster but just your accounts being hit by hackers), you being to pay your bills for one month without hassle is worth it. You can go buy groceries in cash, pay your mortgage in cash at the local bank, pay your utilities in cash, etc. until the problem is resolved. If the problem never occurs, you didn't lose much relative to earning interest because it was only $1500 to $3k

Additionally, 2 months living expenses in "cash" that is readily liquid but invested such as T-Bills in a taxable brokerage account, I-Bonds that have exceeded the 1 year (or will exceed 1 year in 1 month after your 1 month physical cash buffer runs out).

3 months living expenses in gold coins, which should be part of the portfolio anyway. I would hit these up last if needed for emergencies due to the spread on gold coins, which means you take about a 6% roundtrip hit everytime you liquidate and rebuy new ones later. Thus, only sell these if you really need to and preferentially use your paper cash or other liquid cash that makes up 3 months living expenses described above.

Beyond that, I would keep any extra taxable investments you have in gold coins, because that's the best one to keep in taxable since it's the only way you can physically control the coins (as opposed to an ETF in an IRA).

[sophie]

That's a really interesting take on an emergency fund.  In Best Laid Plans, Harry Browne stated that he kept no more than one month living expenses in his bank account, and replenished it by writing a check every month from the Treasury money market fund that held a chunk of his cash allocation (didn't specify how much).  The rest of his cash was in T-bills bought directly or through a Swiss bank.

I haven't completely settled on an emergency fund structure yet.  Currently the goal is to have 3 months expenses in the bank, and another 3-6 months in liquid I bonds and short term treasuries (1 year maturity or less) owned directly.  I also keep some savings in PRPFX that's earmarked for home improvements and other short to medium term savings goals, but obviously could be used as a third level of emergency funds.  Point taken that not all emergency fund money has to be held in cash.

[TripleB]

That's a really interesting take on an emergency fund.  In Best Laid Plans, Harry Browne stated that he kept no more than one month living expenses in his bank account, and replenished it by writing a check every month from the Treasury money market fund that held a chunk of his cash allocation (didn't specify how much).  The rest of his cash was in T-bills bought directly or through a Swiss bank.

HB was retired and could transfer money out of his tax-sheltered retirement accounts into his checking account. Thus, he could keep his cash in tax-sheltered, where it's most efficient, and write do a monthly distribution to his checking. Not sure if that's what he did, but he always said to keep cash in tax-sheltered accounts first.

[dualstow]

I keep cash in taxable for the most part. Every year, though, I max out my retirement accounts. The year that interest rates finally go up, I can leave those 401(K) and Roth contributions as cash. Until then, they mostly hold bonds and stocks. (And a tad of gold in case I have to rebalance out of gold).

[AgAuMoney]

he could keep his cash in tax-sheltered, where it's most efficient, and write do a monthly distribution to his checking. Not sure if that's what he did, but he always said to keep cash in tax-sheltered accounts first.

Interest rates were higher then.  Today cash is pretty tax efficient no matter where it is. 

While you can utilize cash in a Roth or in IBonds or in normal CDs as your emergency fund, realize that it is hard to replenish those once used.  A regular savings account cash goes in or comes out at will.  CDs you may not be able to get as good a rate.  IBonds have annual purchase limits and Roth the annual contribution limit.  Easy out, not so easy back in.

[WildAboutHarry]

While you can utilize cash in a Roth or in IBonds or in normal CDs as your emergency fund, realize that it is hard to replenish those once used.  A regular savings account cash goes in or comes out at will.  CDs you may not be able to get as good a rate.  IBonds have annual purchase limits and Roth the annual contribution limit.  Easy out, not so easy back in.

The point about "...easy out, not so easy back in..." is a good one.  Using Roths or I-Bonds for an emergency fund is OK, but I prefer a tiered approach.  I keep cash (real cash), a regular savings account, a CD ladder, and I-Bonds as an emergency fund, to be used in that order.   

[TripleB]

While you can utilize cash in a Roth or in IBonds or in normal CDs as your emergency fund, realize that it is hard to replenish those once used.  A regular savings account cash goes in or comes out at will.  CDs you may not be able to get as good a rate.  IBonds have annual purchase limits and Roth the annual contribution limit.  Easy out, not so easy back in.

If you hold cash in tax-sheltered that means you have gold coins and/or stocks in taxable. Sell that, preserve your I-Bond and IRA space, and rebalance within the IRA to ensure appropriate 25x4 split. Thus you access the cash held in tax-sheltered/I-Bond but don't actually lose the space.

Of course if you sell gold coins you lose about a 5% spread and if you sell stocks you get hit with capital gains tax, but we're talking an emergency fund here, which is something that is not an event likely to occur. If it is likely to occur then it wouldn't be an emergency and you should probably have cash outside of sheltered accounts for that.

I'd rather than the 1 in 1000 chance of an emergency that I lose a 5% spread on gold coins than a 100% chance that I will pay taxes on cash dividends/yield year after year. Thus, I'd rather hold gold in taxable and cash in sheltered.

[Figuring It Out]

These are all interesting perspectives. And I suppose, in truth, cash would not necessarily be what I'd use first if I needed to tap emergency money - for instance, I have some I-Bonds bought in the early '90s that would be the LAST thing I'd sell, because of the interest they earn. I'd also avoid selling gold coins, because my intention is to never sell them & instead rebalance with gold ETFs. If I did sell them, my finances would be dire.

Among the Roth and tax-deferred IRA accounts, though, it seems that the better expected return should go in the Roths and the non-better-expected returns should go in the tax-deferred - and there's no problems shifting those around every so often. My suspicion is that our tax bracket will not go down in retirement (pension, rental property income, social security, mandatory distributions).