emergency fund and cash

Discussion of the Cash portion of the Permanent Portfolio

Moderator: Global Moderator

User avatar
buddtholomew
Executive Member
Executive Member
Posts: 2048
Joined: Fri May 21, 2010 4:16 pm

Re: emergency fund and cash

Post by buddtholomew » Fri Aug 23, 2013 11:36 am

"This approach could be considered counter-productive as the bonds may end up being more risky than having all of the funds invested in the PP portfolio."

I now realize that conservative investments outside of the PP could introduce more risk to the overall portfolio than simply diversifying into the HBPP. As mentioned recently, the investment earmarked for an emergency (IT-TE Municipal Bonds) has been liquidated with the proceeds reinvested into the 4x25 allocation. I do however maintain some additional cash to purchase lagging assets when a re-balancing band is breached as these funds are held in a taxable account and minimizing taxes is a priority.
"The first principle is that you must not fool yourself and you are the easiest person to fool" --Feynman.
User avatar
sophie
Executive Member
Executive Member
Posts: 3170
Joined: Mon Apr 23, 2012 7:15 pm

Re: emergency fund and cash

Post by sophie » Fri Aug 23, 2013 7:08 pm

Juergen wrote: I just wanted to get something clear in my mind: Is the money I saved as an emergency fund (say the living expenses for one year) part of the cash portion of the PP? If so, any withdrawal in a case of emergency would mean that one could be forced to sell assets like stocks and gold even if there are in the red when the cash portion drops below 15%. Is this correct? And if so, wouldn't it be better to keep the emergency fund outside of the PP? appreciate eery answer  :)
Getting back to the second part of your question....

If all the volatile assets are down, then the cash allocation will have increased relative to the entire portfolio.  Thus, it's unlikely you'll see cash dropping below 15% after a withdrawal.  See the following thread for backtests regarding portfolio performance during a "withdrawal" phase:

http://gyroscopicinvesting.com/forum/ot ... or-a-myth/

UNLESS, of course, your withdrawal constitutes a large portion of the cash allocation.  The problem would be compounded if part of your cash allocation is in tax-deferred accounts and difficult to access.  For this reason, it's probably better to keep your emergency fund separate from the PP until your PP has grown sufficiently large.

I'm wrestling with this very issue myself.  It's compounded by the fact that rebalancing might call for savings account cash to be used to buy gold, since cash in tax-advantaged accounts may only be able to buy stocks and bonds.  Thus, how about this for a rule of thumb:

Keep the e-fund separate until the taxable portion of the PP has built up to at least twice the amount needed for a generous emergency fund.  Note that "taxable portion of the PP" excludes savings for 529 accounts, new car, house down payment, etc.
"Democracy is two wolves and a lamb voting on what to have for lunch." -- Benjamin Franklin
User avatar
frugal
Executive Member
Executive Member
Posts: 902
Joined: Sat Nov 10, 2012 12:49 pm

Re: emergency fund and cash

Post by frugal » Sat Aug 24, 2013 3:58 am

WHAT % of our savings shall we have at home for emergency?

1% hidden at home ?


Regards
Live healthy, live actively and live life!
gizmo_rat
Executive Member
Executive Member
Posts: 304
Joined: Mon Jan 17, 2011 5:25 am

Re: emergency fund and cash

Post by gizmo_rat » Sat Aug 24, 2013 4:30 am

frugal wrote: WHAT % of our savings shall we have at home for emergency?
1 months expenses is a popular choice, but check your home contents insurance for it's coverage of cash in the home.
User avatar
smurff
Executive Member
Executive Member
Posts: 1003
Joined: Mon Aug 16, 2010 2:17 am

Re: emergency fund and cash

Post by smurff » Sun Oct 13, 2013 4:08 pm

Here's an interesting take on where you should put you emergency fund--in stocks:

https://www.betterment.com/blog/2013/08 ... -is-wrong/

The (moderated) comments are as interesting as the blog article.  And this topic seems to have gotten the most comments of any I've seen there.

A lot depends on one's definition of emergency.  I found it interesting when one of the bloggers said IHO repairs for a busted transmission do not constitute an emergency.  That response must have something to do with the company being HQ in a region (NYC) fertile with an egalitarian mass transit infrastructure of subways, suburban trains, light rail, buses, coaches, and shuttles for getting around.

BTW, Betterment is a new, set-it-and-forget-it online investment/advisory service with automated asset allocations and investment schedules based on customers specific goals.  The computer algorithms do all the work.  I don't know anymore about them (not a customer) but what I read on their website.  Their fees seem to average about 0.25% annually, and they seem to have a couple of  family office divisions as their advisors and startup investors.
User avatar
RyeWhiskey
Full Member
Full Member
Posts: 65
Joined: Thu Feb 23, 2012 1:21 pm

Re: emergency fund and cash

Post by RyeWhiskey » Tue Oct 15, 2013 1:01 pm

If the PP is indeed for money one cannot afford to lose, and an emergency fund is indeed for unexpected events requiring expenditures above and beyond monthly planning, then the emergency fund ought not be placed within the PP as the EF is, by definition, money one can afford to lose.

So, theoretically speaking, they should be separate. In reality, it depends on how much you compartmentalize and how much you think about risk/return. An earlier member is correct that your wealth is a coherent whole, but others are also correct that this whole is composed of different parts which play different roles at different times.

Personally, the cash portion of the PP exists for 'tight-money' federal events, not for emergencies. I believe that the Bogleheads are correct that one should have six months of living expenses (rent, groceries, gas, etc...) on hand. Personally, I also think one should have one's yearly Out of Pocket Maximum on hand as well. With both of these in a Savings account you know you are covered well across the board and you don't jeopardize your retirement savings to do so.
User avatar
RyeWhiskey
Full Member
Full Member
Posts: 65
Joined: Thu Feb 23, 2012 1:21 pm

Re: emergency fund and cash

Post by RyeWhiskey » Tue Oct 15, 2013 1:10 pm

smurff wrote: Here's an interesting take on where you should put you emergency fund--in stocks:

https://www.betterment.com/blog/2013/08 ... -is-wrong/

The (moderated) comments are as interesting as the blog article.  And this topic seems to have gotten the most comments of any I've seen there.

A lot depends on one's definition of emergency.  I found it interesting when one of the bloggers said IHO repairs for a busted transmission do not constitute an emergency.  That response must have something to do with the company being HQ in a region (NYC) fertile with an egalitarian mass transit infrastructure of subways, suburban trains, light rail, buses, coaches, and shuttles for getting around.

BTW, Betterment is a new, set-it-and-forget-it online investment/advisory service with automated asset allocations and investment schedules based on customers specific goals.  The computer algorithms do all the work.  I don't know anymore about them (not a customer) but what I read on their website.  Their fees seem to average about 0.25% annually, and they seem to have a couple of  family office divisions as their advisors and startup investors.
A couple problems:
1) Taxes. They recommend investing your emergency fund + more in a 40/60 stock/bond fund. So if you need the money soon you pay short term capital gains, if you need it later you pay long, and your dividends are taxed as well.
2) They advocate that you save more than, say, four months expenses, in order to make up for the volatility of the fund.  But they do not offer the math for the alternative. Ex: $100,000 total wealth, $90,000 retirement fund, $10,000 EF
They say you should go:
$80,000 retirement in desired AA (say 90/10), $20,000 EF in EF AA (40/60).
Well how much more do you really make than if you put the differential 10k into the retirement savings? I would venture the guess that if the retirement savings are in a tax shelter you'd be better off dedicating as much as possible to the higher returning (tax-free) investment and simply maintaining an appropriate EF.
3) It complicates things and plays against most everyday investor instincts. How many everyday people can be expected to feel good about selling a portion (or all of) their EF when it's down 10%? This doesn't happen with an EF investing in cash-like assets. There is no worry or doubt.

Seems like a shill to get more ER out of people. Just my two cents.
User avatar
sophie
Executive Member
Executive Member
Posts: 3170
Joined: Mon Apr 23, 2012 7:15 pm

Re: emergency fund and cash

Post by sophie » Tue Oct 15, 2013 2:35 pm

There is an entry in the Boglehead wiki about using stocks in taxable as an emergency fund:

http://www.bogleheads.org/wiki/Placing_ ... ed_account

It works by keeping an equal amount of cash in a retirement account.  If you need money, you can sell stocks in taxable, and buy an equal amount in the retirement account with the cash you have saved in there.  It's purely to take advantage of favorable tax treatment of stocks, including tax loss harvesting, but it doesn't make a whole lot of sense with the current low interest rates.

Outside of an arrangement like this, the suggestion to keep emergency funds in stocks is totally irresponsible.  It would be a disaster in a recession, and certainly would have been in 2008-2009.  One more reason to steer clear of "services" like Betterment.
"Democracy is two wolves and a lamb voting on what to have for lunch." -- Benjamin Franklin
User avatar
smurff
Executive Member
Executive Member
Posts: 1003
Joined: Mon Aug 16, 2010 2:17 am

Re: emergency fund and cash

Post by smurff » Tue Oct 15, 2013 4:57 pm

Sophie and Rye, the folks at Betterment seem a bit smug and naive.  Apparently they have not lived through many recent stock market corrections, otherwise I can't see how they can give such advice.  It was just in 1998 that a bunch of algorithm geniuses at Long Term Capital nearly imploded the world's economies, and proved that even Nobel Prize-winning economists can't think of every contingency.

It's a good point you made, Rye, about emergency funds which (by intent, use, and necessity) are made of money you CAN afford to lose.  That would disqualify them from being in the Permanent Portfolio.
User avatar
mortalpawn
Full Member
Full Member
Posts: 91
Joined: Tue Aug 13, 2013 11:06 pm

Re: emergency fund and cash

Post by mortalpawn » Wed Oct 16, 2013 11:25 pm

I think it depends on the size of your taxable portfolio.  If you have a small taxable portfolio, then having a separate emergency cash fund is probably more appropriate to avoid having to constantly rebalance, which can have bad tax implications in a taxable PP.  Also if your portfolio is small, you are more susceptible to needing that emergency fund (at least in my experience!).

However, as your portfolio gets larger and the emergency fund becomes a smaller percentage of the total, then it probably matters a lot less as the loss of some emergency funds to handle life's unexpected moments is much less likely to trigger a rebalance event or subsequent tax bill. 

Also I've found as the portfolio size (and income) goes up, the emergency fund gets dipped into less anyways because you have more money in your monthly budget to absorb life's unexpected events.

The key, as always, is to grow your income faster than you grow your spending!
Post Reply