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.
(Check out these good offers from Birmingham Midshires)
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.