Erik Conley had a well written post about whether people might have too large of an emergency fund. He had a couple of very funny one-liners in there too.
The big idea is the opportunity cost of being too conservatively allocated to cash. If you play around with different, decently long time periods you'll see that domestic equities compound somewhere between 8-11% where cash compounds compounds at maybe 3-4%, even less than that over the last ten years or so.
If someone has $5 million in the bank and only needs to pull $100,000 out per year then 3-4% will more than get it done but that won't be too many people. Part of the asset allocation process is to figure out what portion of the total pie needs to capture the effect of whatever the stock market can deliver over the relevant time horizon.
One way you might know you have too large of an emergency fund, Erik says, is that you haven't actually had an emergency. That's funny. Being serious, define your terms of what constitutes an emergency. I shared our story from late 2023 going a few months into 2024 where we had a problem with out septic system. All in it ended up costing close to $4000. Does that constitute an emergency? It obviously was not planned for. If the only way to pay for it would have been on a credit card then that might constitute an emergency.
Earlier in 2023 we had several out of the ordinary car issues, a few things came up that added up to about $2500. We have all had these sorts of things happen. We've never had to shell out $50,000 or $100,000 for something unexpected. All I can think of being that expensive is something medical not covered by insurance or a family member in some sort of serious trouble. Something that big would be an emergency regardless of whether we have the money or not.
How much money should people have in some sort of liquid vehicle for the less dramatic "emergencies" like the ones I mentioned above or to pay the bills in the face of a job loss? There's no single answer there for everyone.
Erik doesn't think people need a year's worth of expenses set aside unless their job situation is very unstable. As we've looked at quite a few times lately, maybe everyone 55 and older's job is very unstable as a large portion older workers get their hand forced at work. At 40, maybe one year's worth of expenses might be excessive but at some age, people need to be ready to "retire" if they get crowded out from their career and can't replace their income. Here, retire could mean be ready to be extremely underemployed. Maybe the career job paid $150,000-$200,000 but what if that ends at 57 years old and the replacement job pays $60,000.
I talk a lot about cultivating and creating income streams and while I have done that personally, none of those would add up to replace what I make from my day job. Living well under our means would make that forced transition easier even if not truly easy.
There are certain basic building blocks to life and personal finance/retirement planning. While I don't know whether people over 50 have always been vulnerable at work or if this is a new phenomenon but I think a building block of retirement planning needs to be building a contingency in case you can't retire on your own terms.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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