I hate emergency funds. In fact, I’m going to kill them. Right now.
I’ve tried and I’ve tried, but you people still insist on having thousands of dollars sitting in the bank doing nothing. There is nothing that will destroy your ability to get ahead more than having a large percentage of your net worth sitting in the ING guy’s pants. (He’s Dutch. Why isn’t he smoking a dube and having sex with a legal hooker?)
Let’s take a quick look at the net worth of someone who follows conventional personal finance advice:
Emergency fund: $10,000 @ 1%
Retirement: $5,000 @ 8%
Debt: ($20,000) @ 5%
Congratulations, imaginary person, you’re going backwards every month. By not paying down that debt, that emergency fund ends up costing you 4% a year. Well played, wealth destroyer.
Now, saying that, it’s important to have some cash on hand. And yes, if you were splitting hairs, you could argue that I’m just advocating another word for an emergency fund. You’d probably be correct, but with one big exception. We’re going to look at your cash on hand and compare it to net worth, rather than looking at months worth of expenses.
Why are we going to do that? Unlike most people writing about finance, I don’t think you’re an idiot. I won’t hold your hand by writing crap like ’82 ways to save BIG this year,’ and then just telling you to get rid of cable and to stop eating out. You’re big kids now, and big kids need to learn how to use the potty all on their own. FINALLY, A POOP JOKE ON FINANCIAL UPROAR.
As I write this post, I have less than 1% of my net worth in liquid cash. I have a little in the bank, a little in my online brokerage account, since I have some uninvested dividends, and a little in Paypal. I also have $12 American, after the vending machine gave me American Loonies instead of real currency. I do not have thousands of dollars sitting in an account, just waiting for an emergency. I have very little cash on hand.
I should probably be shaking in my boots, right? WRONG AGAIN, BUCKO. First of all, I’m not even wearing boots. And secondly, I have access to credit.
A while ago, I set up a $50k line of credit, secured against my house. I went into my bank, met with the attractive loan girl, and was set up in 15 minutes. I was assured I would have access to this even if I lost my job.
I also have a credit card with a limit over $10k. It is a Mastercard, and the number is 4. Steal my identity, I dare you.
Because I’m not a dirtbag, I was able to get enough in credit to weather any emergency. It was easy.
Meanwhile, I have diversified investments. I own a bit of real estate, assets that can easily be borrowed against. I also own stocks, which can be sold in any emergency. Liquid investments are my emergency fund. I’d borrow from the bank to get me through the crunch, and then I’d sell investments to pay off the debt. Easy peasy.
All of this is just a giant long way to say that you shouldn’t have very much cash on hand. But you should have a little.
Everybody should have $1,000 in their chequing account. This will protect you from overdraft fees, and will save you from transferring money between accounts when little things happen. Yes, even if you’re in debt. I give you permission to have a small safety net.
After that? Your cash on hand should never exceed 5% of your net worth, unless you’re specifically saving up for something. So you shouldn’t be exceeding my $1,000 fund until you’re over $20,000 in net worth, and even then I wouldn’t bother. Just make sure you split your assets between your RRSP and your TFSA, and then you can just rob from your TFSA if you ever need to. (And actually invest your TFSA. Don’t leave it to earn low interest.)
That’s not saying you should neglect fixed income all together. Fixed rate bonds can guarantee good interest, and you should always keep some in your portfolio, no matter what your age. Fixed income helps level out your portfolio’s performance in case everything goes to hell again. And it can even make sense to stash it in your TFSA, since you won’t have to worry about tax implications.
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Keeping too much cash on hand is bad. Put that money to work. Creating wealth is hard when a large percentage of your net worth makes less than inflation. It’s time to rethink the emergency fund.
Ha! I feel like I wrote a similar article: http://www.mypersonalfinancejourney.com/2012/09/percentage-net-worth-cash-accounts.html (I made a math error- it should be $105K net worth in the second example). Except that I said no more than 10% of net worth should be cash. I could do 5%. The idea is to create enough reasonably expected cash flow where you don’t need an emergency fund to feel secure, you know there is money coming in next week to take care of XYZ and in the meantime you use your credit to take care of it. I almost have proven I am responsible enough to do that.
A lot of people are going to disagree with you, but thank you Nelson. I needed to read that.
I want a month of expenses but I can’t even get up to $1,000 in my chequing account to avoid the monthly fee.
I have so much unused credit that I could buy a small house yet my bank is determined to give me more. I have a 100k HELOC that I owe $18,000 on but my bank is desperate to give me a 50k LOC.
I have more than enough credit but I want cash. Cash would help me sleep better at night.
What do you have against dirtbags Nelson? Lol.
Man, I must admit, after I bought my rental property, I stopped investing. I have way TOO cash on hand. I’ve been waiting to make the right move, but haven’t done anything yet. What would you recommend?
I have $546 in my chequing account, an unsecured LOC that I used to buy cheap stock with that has a balance of ~ $25k (to be paid off this month with my tax refund and work money) and I lowered the limits on my credit cards after one of them got cloned – so only about $25k available credit.
Nothing comes out of my chequing account without my moving it myself apart from the mortgage. I don’t bother to keep $1k in there when I’m working and know I have a paycheque coming in. When I’m not working, I keep a couple grand. Opportunity cost of nothing.
I have about 1% in cash and $20K open credit if needed. Like you I don’t like having too much cash, it doesn’t make financial sense, although I sometimes have to refrain myself to invest in the first thing that crosses my eyes when I have cash. Waiting for a market move can justify keeping the cash but not a 12 months emergency fund.
Wait, you mean the single guy with no kids doesn’t believe in emergency funds?
I’m not disagreeing with you; I think I’ve got about 5% of my net worth in cash. But with a wife and two kids, we’re ALWAYS saving for something.
In fact, our financial situation has changed so much in the past 5 years that we’ve yet to figure out what a normal, predictable year of income and expenses looks like.
This year it looks like I’ve got about $1,250 a month left over after all of our savings and expenses are taken care of. That’ll just sit around in cash until the end of the year when I’ll decide where to deploy it (mortgage, RRSP, TFSA, RESP, vacation, etc).
So I’ll end up saving $15,000 in cash, but it’s not designated ’emergency funds’, it’s just more of a buffer that I’ll use for some other purpose.
I’m a freelancer. I need money in my EF to pay for daily bills otherwise this happens:
I run out of cash and have to dip into my investments — this sucks if the market is on the low, and not on a high (plus I have to pay taxes on 50% of it for capital gains if it goes the other way…)
When I get contracts, then I plow about 90% of that money right into investing, and consider my new income to be my new emergency fund in waiting (after they pay me of course).
Once it’s in investments, I don’t like to touch it. I REALLY DON’T. I consider it “lost” money because I can’t use it.
I am guilty of having an emergency fund, but the thought of it just sitting there does eat at me. Of course, I want to grow my investments and savings and make some money on them, but I can’t completely ignore the voice that says: ‘your septic tank will die and there’s too much poison ivy in the bushes to be shitting in the woods – you will want to fix that right away’. I’m hoping though, as I learn more about investing this year to get a better handle on a better solution for my EF conundrum.
Not that I know what you do, but what if you lost your job? Those credit lines would be closed ASAP and you wouldn’t be able to leverage anything (at least not in the States).
It’s a little different in Canada. Yes, there’s a risk they’ll pull those credit lines, but I was assured by my banker that I had enough equity the bank knows there’s very little risk of default, and therefore wouldn’t pull the credit line.
Also, keep in mind the LoC is only supposed to be a short term measure, to be paid off as you sell investments.
You do realize that lines of credit are demand loans which means the bank can retract them at any point, regardless of what the attractive loan girl told you. And what happens if you need to borrow money and pay it back with assets that have dropped considerably in the market. Do you really want to have to sell that stock when its down 20%, when you can sit on it and collect that 4% dividend. I agree that too much cash is a bad thing but having a few thousand to get you through an emergency is still sound advice.