Cash Management: How Much For Your Emergency Cash Fund
Posted by Frugal on October 31st, 2006
Many people only look at the cash for emergency usage. In reality, any liquid assets that you have can be counted towards emergency usage. Real estate assets are obviously not as liquid as cash, bank CD, bond, and then stocks, listed in the order of liquidity consideration.
What kind of emergency you may need more cash than usual? I believe that one should cover accidents, medical and death situations by car, medical, and life insurances. If you have disability insurance, that is even better. Please do remember that the social security tax that you pay covers part of your disability and life insurance needs. But one is still left with one of the most dire and common cause for the need of emergency cash fund: unemployment.
Obviously, when you plan for your emergency need for unemployment, you don’t need include any of the cash drain from income tax bites, since you won’t have any income. I think it’s OKAY to keep cash + bank CD to be just 1 to 2 months of your living expenses excluding income taxes. But you should probably have about 9 months to even 2 years of total liquid asset to prepare your emergency needs. You can count some 100% of your bond, and 50% value of any stocks/mutual funds that are NOT directly related to the sector your job is in. I’m using 100% of the bond value, because I assume that in the situation where you lose your job due to economic reasons, economy should be in a deflationary recession, which is usually good for bond investment. I’m using 50% for your stocks, because I because counting all potential losses and capital gain taxes, 50% is probably a good conservative number. You can substitute with any other percentage number for your stocks, but you should only include stocks that you are willing to sell at all cost. Preferably, you should not include any stocks in your absolute core holdings.
In summary, I will set a goal to have a liquidity of 9 months to 2 years (depending on your comfort level), instead of some 3 to 6 months of emergency “cash” fund. Having lots of spare cash is a convenience that you pay for in terms of loss in the potential investment return and/or paying down towards your mortgage. One should be more flexible in managing the money by NOT sticking to absolute cash.
Here is the advice from the traditional way of looking at emergency cash. There are a couple of good advice, but it further shows that one should consider total liquidity instead of just cash.
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October 31st, 2006 at 4:13 pm
Great post. The brilliant Thomas Schweich has done some wide-ranging thinking about emergency funds as well as a host of similar items in his magnificent book “Crashproof Your Life”. I review it here:
http://successbooks.blogspot.com/2006/10/success-book-review-crashproof-your.html
October 31st, 2006 at 4:40 pm
I prefer to use my HELOC as an emergency fund. I want my cash working for me most of the time.
November 1st, 2006 at 6:11 am
Many heavily invested real estate investors seem to have less household cash than those who aren’t. For me, I include the cash in the bank, my Schwab account and my two HELOCs of $250,000 each. I have only used the HELOC twice. Once to buy a condo from BofA that I sold in 30 days (April 2005) and to help pay for a commercial strip center in Phoenix. Both are 1 over prime (9.25%) and have zero balances.
November 1st, 2006 at 8:40 am
Thanks your input Manny.
November 1st, 2006 at 8:43 am
LM&M,
Yes, HELOC is also a source of emergency fund. I will discuss that further in the future. It really depends on how your overall portfolio looks like.
One danger with HELOC is that the amount available tends to decrease during a recession due to housing price going down. And you must have good cashflow to support the additional monthly payment caused by HELOC.
November 1st, 2006 at 8:54 am
By the way, just to clarity, my comment on HELOC was assuming that you have not opened it yet. Hmm… I guess one should open such credit line always?
I usually have too much cash than I can dare to invest. So I never gave too much thought of HELOC in general.
November 3rd, 2006 at 3:57 pm
Buffett always says that it is difficult to get cash when you most need it (since lenders don’t like to lend to people with cashflow problems) so always set up your borrowing lines when you can get the cash.
I also think that cash is seen as a bad thing (in other words that you should be “fully invested” most of the time). But cash should be seen as a position – having ready cash to take advantage of opportunities and not just emergencies, is a key to successful investing.
November 3rd, 2006 at 5:25 pm
Agreed, Doug.
Cash is definitely a position. But one should pay attention to average cash balance. Unless you are a very good market timer or good trader, maybe you don’t want your average cash balance to be too high. It’s important to get a good return on the money you invested, AND ALSO a good return on all the money that you have, invested or “invested” in cash. After all, cash is a position that one chooses to hold, and so the total return must be averaged with the cash that is not invested in other things.
November 6th, 2006 at 6:38 pm
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