Emergency Money

There are all kinds of schemes to have some money on hand just in case in retirement. They range from 5 years of cash on hand to “just use credit cards and leave the emergency money invested. I think in retirement the “just use credit cards” ploy is stupid. When you have a W2 it’s might be an OK plan. Enjoining leverage at 19% is the last thing I would want to do in an emergency, penny wise pound foolish. You incur the full market risk of your portfolio and add a 19% loan on top. But then a big wad of cash is a slow drag on your net worth because of inflation. $1000 @ -2% is worth $800 in 10 years. So whats a mother to do? How about employ the efficient frontier? The tangent portfolio on efficient frontier is the portfolio that provided the most return for the least risk.

This is the efficient frontier of total US stocks v short term treasury. It has an expected return of 7.11% over a 40 year period with only a 3.97% risk. Why would you choose this for your safe emergency money? Most FIRE types are way over risked. They’re all running 80/20 portfolios. In an 80/20 portfolio if stocks drop in half that 80% goes to 40% and you go from rich to poor as you are down to 60% of what you were. In a 20/80 portfolio if the stock market drops 50% you go down 10% and therefore are at 90% of your previous glory. Numerically say you have $500K in a rainy day fund $400K in short term treasury and $100K in total stocks. If the market drops in half like in 2008, you have $400K in treasuries and $50K in stocks, barely a dent. The value of your emergency is effectively maintained.

Let’s say you don’t use your emergency money for 10 years.

Your emergency money grows to close to 1M on the average. Yea but what about inflation you say.

Even with lousy 10% SOR you’re still money ahead inflation adjusted. Just from inflation you would expect your $500K to be worth $400K if you were in cash. This analysis assumes re-balancing to keep the fund at 20/80. If you recall the 1973 recession it looked something like this:

You’ve all seen this picture, it’s from FIREcalc. This is the SOR if you retired in 1973 (red), 1974 (blue) or 1975 (green). In a 73 retirement you were out of money in 20 years. In a 75 retirement you were worth double. 2 years mattered. If you had the emergency fund you could easily live off the emergency fund for 2 (or 5) years while the market recovered effectively indexing your retirement from a 1973 loser to a 1975 winner. Can’t do that with a credit card. It turns out in my analysis you would only need to use this money once to save your portfolio. The graph also informs you a bad SOR still lasted 20 years, one year of indexing to a 74 retirement lasted all 30 but lost some and a 2 year indexing lasted all 30 and doubled, so the risk is early and takes a while to manifest but the manifestation is relentless. 10 years into your retirement you can probably begin small withdrawals from your “emergency money” to supplement your income if you don’t need it to save your bacon, and still keep a nice pot around “just in case”.

I was alive and kicking in 73 and my first year of investing was 75. I remember it. Retired people were freaked out. People talk a big game about their risk tolerance. I’ve lived through and remember 1960, 65, 73, 80, 87, 93, 2000 and so on and so on. One thing is for sure if you whip it out someone is going to cut it off. A little cash in an emergency fund tangent portfolio is just the ticket against the castration of too much bravado.

6 Replies to “Emergency Money”

  1. I’m still trying to wrap my head around treating each bucket separately instead of as part of the same portfolio.

    Maybe I’ll conceive of it as musical scores. Retirement is a show tune. Small speculative bucket is punk. Emergency is Muzak.

    This illustration of a 20/80 emergency fund is very compelling.

    I was born in’73, perhaps I’m a Rosemary’s baby for stocks? A harbinger of evil tidings? That graph of two years difference in portfolio survival tells everything you need to know about risk.

    Thanks for the clear illustration,


  2. I saw firsthand many colleagues who tried to retire around the dot com and 08/09. It was not pretty. Many quietly returned to practice or just shot past their planned retirement date. It will be VERY interesting to see how cavalier folks will be when they are retired and half their money has vanished.

    Folks always think that they will be different. I have come to accept that if something has happened to others, I will not be immune. Thus like you Gasem, I plan for it.

  3. I agree a lot of docs get away by using credit card available balance as their emergency fund because of perceived cash drag. While working I am sort of in a hybrid model.

    Whenever I get a paycheck (bi-monthly) I pay off all debt (thus pay off all credit card balances 2x/mo) plus the recurring items I have (which is barely a blip on the radar). The excess money from my paycheck I then immediately transfer to my online savings account where it sits, earns a little over 2% now, and builds. Invariable when it hits around 6 figures or so I usually have an investment opportunity that I will then drain from this account (like to leave at least 10k balance). The process then repeats. So far it has served me well but only works while I’m still working.

    1. I know you’re into the property syndicates so that schedule makes sense. The problem is when people become frozen with half a mil sitting in the bank paralyzed and unable to pull the trigger after a loss or waiting for a “pull back” or driveling about “dry powder”. Money only creates value when it is placed at risk.

  4. Analysis of this period is very revealing. In 1960 the average guy making the average wage could support the average family. By 1965 Johnson had ushered in the great society which was a socialist give away to buy votes. Free shit for the po’! In addition taxes were high and Johnson had vastly expanded Kennedy’s war to satisfy the military industrial complex. We were trading children for profit and Boeing and Grumman et al got rich. I was draft-able at this time so it mattered to me since I was potential cannon fodder. The give away by Johnson caused recession, why work when you can get it for free? This is when creating babies in fatherless homes became an industry and decimated the black family structure and some whites as well. If you were on welfare you made more money with more kids as long as there was no “husband” in the picture. So by 70 roots of inflation was rolling. Joblessness and bad economy caused easy money which overheated interest and we had hyperinflation and economic stagnation aka stagflation. No jobs rising prices. Further more OPEC embargoed oil and soon enough we had no gas which led to rationing. Peeps got pissed at Nixon with his inability to deal with Johnson’s mess and impeached him. Carter got elected and nominated Volker to the FED. In Nixon’s time Volker was in the admin and managed to get the US off the gold standard. The gold standard was a source of constant recessions/depressions dating back a century and by floating the currency you could print money ad lib. One way out of inflation is to print money. Need more money? Just expand the money supply. Probably whathas saved the country most in the last 50 years, no gold standard. By 79 when Volker was appointed he knew what to do. He raised interest to 20% and squished the inflation flame. Then Reagan came and cut taxes which stimulated the economy so by Reagan’s second term things were better. You can see this reflected in the graph above. 13 years in things take off. 13 years = Reagan’s second term. A couple other things happened. In the 70’s Japan became an economic powerhouse because of hyper-productivity. Productivity is the motor that runs an economy. The country with the highest productivity wins. The solution to low productivity is creative destruction, so we got busy and created computers and information technology at a personal level hence Apple and Microsoft etc. Also because of economic hardship and “woman’s liberation” the woman in the family acquired a second job and went to work in the work place. This booted productivity out of the stadium at the cost of a stable family. You can have it all became a reality for a short time. Nobody was home minding the homestead when both parents were in the shop working. What happened was land inflation. The first thing mama wanted with the new found job money was a bigger place and mama got what mama wanted so housing prices soared as productivity soared. It was a trap. Once housing prices soared you needed 2 income to live the average lifestyle and COULD NOT go backward. Have it all was no longer a choice but necessity. This is how all those rambley brownstones in NYC or track homes in LA went from 50K to 5 mil in price, the result of “liberated” productivity. So parents were trapped in 2 incomes necessity and kids were left to fend for themselves and the schools stepped in, in their benevolence to brain wash them. Brownstone owners sold out and moved to FL, L A track home owners sold out and moved to Nevada and AZ, nice windfall but there isn’t a third partner to go to work so that boon doggle isn’t going to repeat. Ensconced in all this is the economy. All of this gets reflected in the “averages”. The entire FIRE movement is built upon the “averages” because it’s something of a mirage. In order for the averages to play out things like productivity and inflation needs to remain intact. Debt needs to be controlled. Employment needs to happen. Give away’s need to be addressed. Open boarders = death to productivity. Debt = death to productivity. Theft of intellectual property = death to productivity. Socialism = death to productivity. Military adventure = death to productivity. Dems da fax jak. So if you think tomorrow is going to be better than today and expect that productivity to continue to trickle into the averages from where hence does the “new” productivity emanate? From gender studies majors? From clueless ex bartender congresspeople who want to tax you at 70%? From political hack alcoholic speakers of the house and a news media who promote disunity, discontent and jealously with the intent of feathering their own nests? Lemme see, you just save up 25x your income in low cost mutual funds…

    Did you ever notice that FIREcalc goes back to 1871 to create it’s averages? What’s 1871 have in common with today? Not much. So why would you base your future on that 5 generation old past?

    I’ve been wondering if there is an unrecognized nugget of efficiency built into a 2 tier multi risk portfolio. The reason bogglehead works is because the 2 fund is on the efficient frontier and the system is mechanical. This means for a given return you automatically own best risk and for a given AA you automatically plug in new money every year. As long as you do that your portfolio will profit with pretty good efficiency. Start messing with the system and very likely you will do worse in the accumulation phase. In accumulation the portfolio is closed to SORR What if deflation is different? What if it’s more efficient to draw money from a tangent portfolio which is open to SORR? The system then becomes an issue of when and what account to withdraw from? In up years where the market pays you more than expected return take some money from the excess return and put that into a low risk tangent account. This is like selling high to buy low. On years when the market is down use low risk money to live on and close the high risk portfolio to withdrawal. This is effectively selling the low risk money high by not selling the high risk money low. So last year the market was down 8%. So extract money from the low risk account. If the market is up this year by more than what the average predicts, pay yourself then add some money to the low risk account effectively dollar cost averaging the risk overtime. It would likely limit absolute upside but it may improve risk from portfolio failure. It would definitely protect against a 1973 type fiasco and probably 1929 as well. The problem with the high risk portfolio is it takes a long time to get to even once there is a down turn which is worsened by WR. If no WR is extracted recovery time should be shorter and over decades should improve the outcome. The low risk portfolio is mostly bonds anyway and pretty immune to SORR. My latest brain storm.

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