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I actually have a somewhat controversial opinion (that shouldn’t be controversial because it’s all math, but it still is regardless) that, after you save 5-6x y
by Moodles 6y ago
I actually have a somewhat controversial opinion (that shouldn’t be controversial because it’s all math, but it still is regardless) that, after you save 5-6x your emergency fund, you don’t need an emergency fund at all and you’re better off investing it all in a total market index fund. The reason being that even if there is a market crash, you’ll still be able to afford the emergency since you’ve saved multiples of it already, and in general in the long run having stocks instead of cash or T-bonds in an EF will be better. Various blogs have done the math and it all checks out, but people still push back at me for this. Having an EF if your net worth is a few multiples of your emergency fund, is entirely psychological. Which is fine. But people should just be aware that it’s a bias they have.
Perhaps investing on margin is the same. I have personally taken the leap and got rid of my emergency fund. But I haven’t looked at investing long-term on margin yet. I did see a test from HEDGEFUNDFIE on bogleheads forums about this. But I haven’t looked into it. I definitely think taking out a margin loan while simultaneously having an EF in cash makes no sense though.
- fairity 6y agoI’ve thought about this too, and came to a different conclusion. The primary reason is just because the markets haven’t collapsed more than 85% over a months long period before, doesn’t mean it won’t in the future. And, my marginal utility for money gets so high below a certain level, that it’s not worth risking this outcome when the marginal utility of more money is relatively smaller.
- Moodles 6y agoYeah, it’s essentially just estimating the probability of you getting an emergency which coincides with a total market collapse so horrific it reduces your semi-liquid net worth to less than your emergency. I’m at a point where I’m ok with that risk. At some point you would be too: 85%? 90%? 99%? Clearly we agree Jeff Bezos doesn’t need 6 months cash on hand at all times. So the limit is somewhere. I think a total market collapse reducing the Dow Jones to like 3,000 is pretty unthinkable at this point. Or rather, if it did happen, there are bigger problems than my cash, like the zombie apocalypse which caused this horrific stock market collapse.
- fairity 6y agoMakes sense. 99% sounds about right for myself. But, how do I estimate the degree of downswing that I'm 99% confident will never happen in my lifetime? Or, is there a way to buy options to protect against this outcome that would economically make sense? Thanks!
- Moodles 6y agoYeah it’s hard. There is about 200 years of stock market data so I would look at the biggest crashes to get a sense of what the biggest of them all could be. I guess that’s the German tank problem. It seems very unlikely we’ll get a crash relatively twice as bad as the Great Depression though
- sanderjd 6y agoWhy does that seem very unlikely? It seems to me that the right way to think about that is that the likelihood is simply unknowable either way.
- Moodles 6y agoIt seems very unlikely since there's 200 years of data to show that was the biggest crash ever. So a crash twice that size is very unlikely. You could do the math to calculate the exact probability given the sample size of stock market years.
- xchaotic 6y agoI think the central banks and government will prevent any future collapse of that scale. Don’t fight the fed. They have more money than you.
- cortesoft 6y agoThe bad part is that you are going to have to pull money out of the market at the worst time, when prices are way down.
- Moodles 6y agoYou won't necessarily have to, but yes, no risk no reward. Doing this is what people who have retired have to do whenever there is a market crash. Really this shouldn't be that controversial. It's super simple: Which does better long-term? Stocks or cash? That's pretty much all I'm saying. There's a ton of data to back up what I'm saying. https://earlyretirementnow.com/2016/05/05/emergency-fund/ https://earlyretirementnow.com/2016/05/05/emergency-fund/
- imtringued 6y agoYou have $100k. Put 80% of it in the stock market. The stock market drops by 40%, your investment is worth $48k and you withdraw nothing but spend your entire emergency fund. The market recovers and now your portfolio is worth $80k. You have $100k. Put all of it in the stock market. The stock market drops by 40%, your investment is worth $60k and you withdraw $20k. The market goes back to 100% and now you have $67k in your portfolio. If the market dropped by 80% your portfolio would be gone entirely. Meanwhile if you had enough emergency funds you would have kept everything. The worse the emergency, the higher the ROI of the emergency fund. Since there is no upper bound for how bad an emergency can be the theoretical ROI of an emergency fund is also unbounded. In this comment the definition of an emergency is a stock market drop combined with unexpected unemployment.
- sokoloff 6y agoThat’s another use of margin. Invest 100% (but not more). Emergency hits and you can withdraw cash without selling stocks (up to a point).
- Moodles 6y agoI mean honestly, using a credit card for a month before interest hits is usually fine too? My credit limit is like 50k or something ridiculous across all my cards. Not to mention when all in on stocks you can sell for better long-term capital gains tax treatment or even tax loss harvest losses too, which you can't do with a savings account. And ETFs are actually pretty liquid: I can sell and withdraw in a few days if I wanted to anyway.
- sokoloff 6y agoYes, but then you need cash to pay off the credit card, which is cheaper to pull from your margin available than to let the credit card charge you interest.
- Moodles 6y agoI'm not suggesting to pay credit card interest. I'm saying you can cover any emergency expense with a credit card which buys you a month, and then you might have ordinary salary or time to sell your stocks before interest is due. No offense but I'm pretty surprised you commented what you did. Literally my first sentence says "... before interest hits...".
- loxs 6y agoThis sounds true if you only optimize for (hedge against) one risk only - stock market crash. To me, an emergency fund is a hedge against various different risks like these (I am guilty of not being prepared for all of them): 1. A pandemic. For this I was ready even before we thought it's indeed possible - I have funds in several different banks (debit cards) that allow me to not have to visit a bank physically for several years (even if some of the cards expire in the meantime, or one bank suddenly goes bust) 2. AI glitch, identity theft, a bank holiday (this happened to me actually some years ago) that blocks you from accessing banks (and investment brokers if you have nowhere to withdraw your funds) for several weeks/months - for that you hold paper cash, physical gold and cryptocurrencies stashed at different physical locations. 3. Natural disasters - again some combination of diversified physical and virtual funds 4. Legal trouble - yes, even if you are not guilty you could get your funds blocked. I presume you are from the US, hence the purple goggles ;) (I hope I'm not offending you)