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There are certainly a number of good reasons to hold a traditional emergency fund, but there are also arguments to be made against them for people with the means to fund an emergency without subjecting your dollars to significant cash drag.
Let’s see what the good doctor’s reasoning is. As always, this post first appeared on WCI Network partner site Passive Income MD.
Before we get started, I wanted to include a small disclaimer: every situation is different, and what works for me may not work for everyone. I’ve crunched the numbers and found that an emergency fund isn’t best for me. Will it be the same for you? That’s what you’ll have to decide for yourself. With that in mind, let’s dive in.
What Exactly Is an Emergency Fund?
As you probably know, an emergency fund is meant to be a buffer for unexpected costs or bumps in the highway of life. These might include the following (all are things I’ve experienced):
- Unexpected health care costs, like an ER visit for broken bones, suspected appendicitis
- Car issues: blown tire, broken windshield, etc.
- Unexpected house issues: roof leak, broken pipes & subsequent flooding
- Unexpected pet costs (my dog inhaled a foxtail and it required a $1200 procedure to remove it)
- Job loss (I actually haven’t experienced this, but I know it’s a reality for many people)
Given how devastating unexpected events like these can be to the unsuspecting family, most financial experts (like Dave Ramsey) recommend that your emergency fund should be able to cover 3-6 months of full expenses. Exactly how many months depends on the stability of your job, whether you have dual incomes, and how healthy you are. Suzie Orman even advocates for 8 months of full expenses!
Now, I’ve read Dave Ramsey’s Total Money Makeover. In fact, I recommend that most people should read it. Having read it when I initially finished my training, I built up a sizable emergency fund and I was confident in my ability to weather any storm.
Then… I watched as that cash sat there and did nothing. All I could think about was how it was wasting all of its potential.
I began asking myself whether having an emergency fund was truly the right thing for me. I decided to do a deeper analysis, and spoiler alert, I decided against the emergency fund altogether.
Why I Feel I Don’t Need an Emergency Fund
So, here are the considerations that went into my decision:
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- We are a dual income family – I work a little less than full-time. My wife is a doctor and although she only works part-time now, I know that in a pinch we could both work more.
- Delayed payment from work – In terms of billing, I am paid on a two-month lag. For example, on March 1st, I get paid for what I did in all of January. There is almost always a lag between service, billing, and collection. So I know that if something comes up, I’ll still have a paycheck coming in for the work I’ve already done.
- Disability insurance – Not only does it cover 30% of my current income tax-free, but I’ve also added a partial disability rider. If I experience a drop in income of more than 15% due to a disability or injury, after a period of 90 days, my insurance company will start paying me to compensate for the difference.
- Passive income – Of course, this is a big one for me. I’m earning passive income from other sources, which currently covers over half of my expenses.
- Home equity line of credit – I opened up a HELOC that is maintained for only $75/year. If I had to use it in a pinch, this could cover 10-12 months of expenses.
- I’m decently adept at selling things online (Ebay, Craigslist, FB) and if it really came down to it, I could sell some of my possessions. I’d start with some of my wife’s nice purses (shhh, don’t tell her).
- Opportunity cost. This is a big one. Sure, I could have funds in a high-yield savings account like Ally, but with an average yearly inflation rate of 3%, a 1% return simply isn’t enough. I wanted to put that money to work.
What I Used That Money For Instead
So what happened to that sizeable emergency fund of mine? I chose to invest it and so it went to (and continues to go to) crowdfunding, investment properties, and taxable accounts, to name a few.
When an unexpected event does occur, like that $1200 procedure when my dog inadvertently sniffed something up his nose (which has happened twice, by the way), I put it on my credit card. By the next month, I’m able to pay it off in full as my paycheck comes in.
I’m fortunate enough to have a buffer and don’t live paycheck to paycheck, and I always pay off my credit card in full every month. If the worst case scenario occurs and the expense is very large, I could tap into one of the resources mentioned above, like my HELOC.
Ultimately, this is just one situation where I decided that the conventional wisdom just wasn’t right for my particular situation. Obviously, I believe that you need to be prepared to handle life’s unexpected circumstances. After all, the one thing we can count on is that life is unpredictable.
I say, make sure you’re prepared for an emergency, but do it in a way that makes sense.
Has anyone else eliminated their emergency fund? Anyone think I’m not being smart about this? I’d love to hear…
39 thoughts on “Why I Don’t Bother With an Emergency Fund”
I used to do as you do and probably would again if my situation was as secure again, when I was made redundant from a (relatively) high security job I took the opportunity (reasonable redundancy payment) to do some non profit work and not having the security of a fat pay check, respectful professional employer, good pension and proper sick pay etc made me want to keep a lot more cash handy. As a result I now hold about a years handy cash (and I have enjoyed and used the security of the FU money as I have been hopping between poorly remunerated (some exploitative), for the feel good factor roles). I’d go back to a middle ground if cash holding in the future though based on the security and replaceability of my employment and passive cash component. I think as long as it’s a conscious decision how much cash to hold and your/anyones reasoning makes sense/a plan of what to do in adverse circumstances is available whatever your decision is it’s likely to valid.
I think the current events are an excellent example regarding the ‘why’ of having an emergency fund is important. For those who would ‘just sell from accounts’ that plan suddenly becomes MUCH less palatable in times like these. An confluence of a global event, add in a looming recession-if-not-depression, and throw in a loss of income, and one NEEDS liquid funds. It was easy to invest away during a charmed period in the market, but for now I am seriously glad I have my recession/depression insurance (a military pension) and 2 years of extra cash, and a relatively basic lifestyle. Particularly as I gave notice to my job at the beginning of March! Asset allocation matters. Don’t get blinded by trends, good or bad.
Hi PIMD, would you please elaborate on the HELOC you’ve opened up that takes only $75/yr to maintain. Thanks
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I am in the minority here too. 16% of my net investments (stocks, mutual funds, bonds, cash – debt) is in cash. Having lost a high paying job during the great recession where I had to move out of state and then was upside down on a property for five years as an involuntary landlord gave me a personal experience of what it’s like to live through a downturn that I was eager to not have to face in the same way if I ever had the displeasure of experiencing again. I’m not in a profession where I can bank on finding a similar job in 2-4 months (maybe not even a year). That cash percentage will walk down probably a percentage point a year going forward. I’m sure there are people that think the cash drag is crazy, but I sleep better at night knowing that my family could go 1-2 years without having to make radical life changes (e.g., geo move) if needed.
I like to keep 2 months of expense in our checking account. This gives us a buffer. The investment drag isn’t a big deal. This amount is less than 1% of our portfolio. Our finance is much more tenuous than your too. Your finance is rock solid.
We’ve lived through a pretty charmed period of investing with extremely low volatility and reliable returns and a Fed that has forced equity investment to become the only game in town. Equity investment involves a lot of risk and while we “know” that, a lot of the recent generation of investors haven’t really experienced that. Cash or something like the ETF BIL is a perfect way to reduce overall risk in a portfolio. The correlation between BIL and VTI is -0.15% meaning your cash tends to gain a bit of value when the Bear comes along. Reduced risk means when the crash comes you loose less, and therefore need to make up less to get back to zero. Plus you have some powder to spend riding the wave back up.
In Spring 2003 right as the Iraq war started I had $1M sitting in cash, from money I had tax loss harvested after the dot.com bust. I was sitting in the Doctors lounge trying to decide what to do and I asked asked myself: do I want to bet for or against America. We had suffered the dot.com fiasco, 9/11, and now war. I was in the Navy when Iraq 1 happened in 89-90 so I figured Sadam wouldn’t be hard to handle but the media was nothing but doom and gloom. I put it into SPY. You can look at the chart. Buy low sell high. But if you don’t have any cash how can you buy low? I tax loss harvested again in 2009. I’ve made a lot of money in the past 10 years so recently I’ve recently taken a little off the table. Once I’m through my period of SORR concern during early retirement… Buy low sell high. Just saying there is another side to risk management beside being cajonies to the wall equities invested at all times.
I keep roughly $150k in cash (about 3.75 percent of my portfolio) for many reasons. First, as some folks have noted, its good to have cash ready for new investments with a short opportunity window.
Second, my preference is to avoid withdrawals from my investments for ANY reason during the accumulation phase – doing it one time might make it easier to do it again.
Finally, a cash hoard helps with a hybrid 4 percent strategy, where you take less than 4 percent when the portfolio is down (to avoid sequence of returns risk), and make up the difference with cash. I should probably consider minimizing the cash account during the accumulation phase, but see numbers 1 and 2 above. ?
I always have at least 10% of investable assets in cash. When opportunities come by, I enjoy having “dry powder” to play with. It has always been helpful. I am also not in the accumulation phase any longer since I am almost 50 years old.
I have lived through enough down markets to know what it feels like when opportunities abound and I can’t take advantage since my capital was already tied up. I promised never to do that to myself again.
First of all, your dog is adorable! We nicknamed our dog The Main Expense, as he is high maintenance and the family member we spend the most money on. I think an emergency fund is necessary for any dog owner!
I think the wealthier posters above have it right. The amount of emergency funds is like an inverse bell curve:
We start off needing an emergency fund to carry us through a job loss or large purchase.
Then, those of us in or almost in FI, we think we don’t need one because we can liquidate taxable accounts and have this insatiable desire to squeeze every bit of return out of our money as we can.
Finally, with wealth well beyond FI, we realize we don’t have to squeeze every ounce of return from our investments as we can, and $500k in chase drag is of little concern. It helps us sleep at night and allows jumping into opportunities that those without the cash can’t.
Emergency fund is a good idea until you are FI. After that it is such an insignificant amount of money that you could dig it up in ten minutes from any of your fixed income investments or you probably have that much sitting in your checking account. Using debt, like a heloc, in an emergency? That’s crazy talk.
I have discussed this issue here (https://www.physicianonfire.com/top-5-reasons-physician-holds-500000-cash/) in the past). I am an outlier in the FIRE space on this issue. Some of it may be to do age and station in life and some do to a cautious nature when it comes to such things.
I currently have 5+ years of baseline living expenses (ie. No European travel) in cash, intentionally, in case of emergency, the biggest of which would be dual job loss. While it sounds unlikely, we have both been burning out, and the possibility of a dual exit from current job with no forward earnings plan in the next 2 years is very high. Additionally, in our 50’s jobs are going to be harder to find than for someone in their 30’s.
By most accounts, we have enough to retire today, so having a drag on returns is not as large an issue. Even when I was younger and earlier in my career, I always felt more comfortable with a larger than average cash cushion. Some people just need this to sleep better at night.
The delayed income part and the other sources of income do help. But it is probably a good idea to have some cash on hand anyway just in case. For example, you don’t know if a HELOC or credit card will be available in a financial crisis. With regard to the passive income, it may also fluctuate depending on the source. Companies can reduce dividend payments, tenants may not pay rent on time, etc. And disability policies can take a month or more to kick in. Besides, the opportunity cost on a relatively small amount of cash probably isn’t that great. Especially for the extra peace of mind it can provide.
2 physician income, young family and high negative net worth with student loan payments of $10k/mo (total budget $20k/mo)…I opt to keep 8-9 months in vanguard high yield tax exempt bond fund… Earns about 4%. Sure, there is interest rate risk, but feel the chances of needing the money are very low, so willing to invest for long term and reinvest dividends.
I’m in the same place – I’ve got enough income coming in to cover any large expenses, and my income is also already banked in a business account for a few months. I’ve got no dual income to rely on, but I’m happy to liquidate investments if I need to.
The opportunity cost is real, especially given current cash savings rates. And I’d argue that those you quote are expected expensive, you just can’t control the timing. People seem shocked when things wear out and break, but we should we all really be planning for these eventualities.
I don’t have an emergency fund, per se, but I do like to maintain a certain level of liquidity. That is, I allocate a portion of my personal net worth to cash. While this cash could be deployed to cover emergencies, its primary purpose is to serve as ‘dry powder’ for bigger, opportunistic investments (such as real estate or a business). I personally prefer a target of 10% liquidity (i.e. $1M net worth = $100K cash), but I don’t panic if it falls to 5% from time to time. Author Russell Holcombe, in his book You Should Only Have to Get Rich Once, says he prefers to maintain 20% liquidity.
I think the disclaimer at the beginning is important because we all have our situation, and experiences, and what makes us comfortable to sleep at night.
For those of us who, like Dave Ramsey, forego debt altogether, having an emergency fund is a must. And if you think about it, you’re not losing much opportunity cost with a 3 month emergency fund. It’s pocket change in your plan. You are insuring yourself with that money.
For other readers out there, one use for the emergency fund is to cover you until long term disability kicks in, that 90 day waiting period. Or cover the gap and pay COBRA before unemployment, or if you don’t qualify for unemployment. These are the sorts of unexpected events that people may not immediately think about. The point is that it’s there when nothing else is.
I’d venture to guess you have access to enough cash in different places to qualify for at least a few months’ expenses, even if you don’t call it an emergency fund.
You may be right. Another benefit of relative frugality is that every paycheck replenishes a significant portion of your monthly spend. When I was working full time, my takehome pay every two weeks was good for 7-8 weeks of living expenses.
Cheers!
-PoF
We’ve backed down from 6 to 2-3 months and keep it mainly for psychological benefit. After living paycheck to paycheck in training its just not a good feeling have a low balance.
This is mainly for job loss before the disability kicks in 90 days later. However, we are basically financially independent so I should probably consider dropping the DI. More psychological reasons rather than financial….
2 months more than adequately covers the one off expenses like dogs sniffing fox tails or car repairs. I also make sure it covers of medical insurance deductible for some reason.
I consider my inherited IRA (no early withdrawal penalty since the original owner was past the age of penalty at death) and my taxable brokerage account to be my emergency funds, and I’ve never needed to use either. In the rare case of an actual emergency so costly that it doesn’t just go on a credit card and get paid off next month, capital gains taxes aren’t going to be my biggest concern.
Same here (minus the inherited IRA).
Best,
-PoF
Whether you admit it or not, you already have an emergency fund, your wife’s’ second income and your own passive income( which makes up half your total income ). Without those two factors , I suspect you might have a different approach.
I’m not the author, but my situation is closer to the one you describe. My wife has stayed home to raise our kids, and I am no passive income master, although the larger our taxable account grows, the more dividends it kicks back.
We’ve kept our emergency funds pretty low. I could always sell from taxable or use a credit card to float until the next paycheck comes in. I also like some of PIMD’s other ideas, like selling stuff you don’t need, which is probably a good idea at any point.
Best,
-PoF
I am in a similar situation in respect to two incomes. I am paid monthly and my wife is paid every two weeks. I think this lowers our emergency fund need, so I have backed it down from 3-5 months expenses to 1.5 months expenses. I also am fortunate that we have a full checking account that pays 2% APY on up to 25k, so it keeps better pace with inflation and is completely accessible. Now that we have paid off student loans, our emergency fund could probably be even leaner.
Sounds like a good position to be in, SG. My “ready cash” that you could call a small emergency fund, tends to be about the same size. At least enough to cover the monthly credit card bills, and a little bit more.
Best,
-PoF
If you do pull the trigger and RE, will you expect to change things on the cash front?
Reasoning here is completely right for me too. Our emergency fund is just enough to pay our current bills. Heloc is extra protection!
I think establishing an emergency fund is like putting training wheels on your bike: It is a good and important step to do in the beginning. Later, you may get away without them okay.
Given my household’s frugality, net worth, FI, income streams etc. I probably don’t need much cash hanging around. On the other hand it provides some psychological comfort to me (and my wife) and gives me money that I can deploy quickly for an investment. I find opportunities come up quickly and then the window closes so I want a six-figure sum available at any given time for investment purposes. I could use it for emergency if one happened. I also have a HELOC, although it may be less valuable now that the interest isn’t deductible (is that a change in the new tax law?)
I’ve lowered the amount in my emergency fund over the years, but still keep one. Like you it pains me to see that cash only earning a minimal amount in a credit union savings account. But with your situation, especially the delayed pay, I can see why you would eliminate it.
We are in a similar financial situation and we don’t have a dedicated “emergency fund,” but we can handle unexpected costs with a credit card and time. I think one of the big benefits of an emergency fund (besides the obvious financial one) is not having to worry about how to pay for an emergency when the emergency happens.
The emergency can be stressful enough and having a fund there to handle the money aspect can take a big weight off your shoulders.
If you’re in a situation where the finances aren’t going to be an issue, with or without a dedicated fund, then you have all the benefits of that emergency fund plus potentially higher returns because it’s not stored in a savings account.
I know a bunch of people that didn’t have have an emergency fund while they were working for the government as they thought, “I’ll always get a paycheck every two weeks.”
That was a mistake during the shutdown a couple of years ago. They ended up having to call up their bank to say they couldn’t make the mortgage payment until they got paid.
So while I totally understand your reasoning for not having one, for me even being in a secure place like the government I like having a bit of breathing room 🙂
I think you’ll agree that having a paycheck is not the same as what PoF outlined. If missing one paycheck means you can’t make a mortgage payment, you’re not nearly as financially secure as the scenario PoF outlined. Not by a longshot!