holding cash tactically for future equity market deployment is a separate topic of discussion.
also, when holding a 60/40 portfolio, the longer the duration the better for risk reduction purposes. try 4%+ on a long-term corporate IG bond portfolio and ~3% on long-term govies.
i only present the 60/40 portfolio for the naysayers that want a portfolio that they can access should the ish hit the fan so bad that they need to exhaust all credit and all savings to survive. you can keep your emergency savings in 100% equity if you’re confident in your employability.
I get it and I have a HELOC and emergency fund typically, although sometimes cash runs low if I’ve made a lot of investments recently. Here is a scenario for you:
Assume I have no HELOC and just an emergency fund and I listen agree that a HELOC is superior. As of today, I open a HELOC and invest my emergency fund in a 60-40 portfolio.
We are a single income household. I work in asset management. The market tanks next month and I lose my job.
My house value is cut drastically and my HELOC is called in.
I am forced to sell my 60-40 portfolio to fund my family while I search for a job.
I just lost money in that scenario. Having flexibility is what is important to me.
Time of entry matters. The above assumes the market tanks immediately. Holding for a longer period doesn’t cure all. If I bought the S&P 500 in January 1999 and lost my house and HELOC in January 2009 (which actually happened to many) then the S&P was down 18% after holding for 10 years so maybe in a 60-40 portfolio with the bonds/inflation I’m at break even with infinitely more volatility and risk of human psychological error. I think about the emergency fund as an insurance policy. I know I am likely to lose some money and I am willing to accept that to prevent a personal catastrophe…more of an insurance mindset. I suppose it is likely down to personal preference.
it is about maintaining a strategy over a lifetime. it is extremely unlikely that you will experience the worst possible set of events over and over again. just because you are slightly worse off in one of the worst possible scenarios, doesn’t negate the lifetime positive impact of not maintaining a large perpetual cash balance. it does take some fortitude and likely only professionals and investors with a trusted advisor can consistently stick to it for a lifetime.
also, living in a major city where your home cannot fall enough to result in a HELOC margin call is advantageous. for example, if you live in new york, during the worst housing market collapse in us history, it took 6 years for prices to drop 23% from peak to trough. even if you bought at the exact peak, you still had some downpayment initially and 6 years of equity building which would result in the bank likely giving you a pass despite the price declining over time. additionally, most banks aren’t in a hurry to throw you out of your home if you’re paying your mortgage. even in phoenix, where you could have been 30-50% under water, the best case scenario for the bank is you keep paying your mortgage. it would be disadvantageous for the bank to call in the heloc and take possession of a negative equity property.
it is important to be mindful that it is not that you are “likely to lose some money”. you are giving away 1/4 to 1/5 of your total lifetime savings (on average) for little reason and are putting your family at greater risk over time as a result.
that said, as i stated before, canadian entitlement programs make it much easier to have absolutely no emergency fund as they act as a an asset in times of duress. if they are the equivalent of two months salary on a pv basis then i suppose that is the maximum i could live with recommending.
That is true when you are earlier in your career and your emergency fund represents a significant amount of your net worth. There is no way that holding a half a year’s living expenses in perpetual cash would have have 20% to 25% hit on total savings (assuming you mean at retirement) for most. If it does they are either overestimating expenses or retiring at 80.
In your example, if you hold $50k perpetually for 30 years at a 7% rate then that is ~$380k. I am just assuming $50k here as a mid-point for an emergency fund as expenses fluctuate from age 25 to age 55. Let’s assume you keep it in cash under your mattress and you are giving up $330k over 30 years, $11k per year is the cost of insurance (notably, in future dollars). I think what you are saying is that that cost is higher than many realize, which is probably correct.
it’s bigger than you might think. the math is simple.
if your emergency savings is effectively the first non-retirement funds you accumulate, if you establish this amount by age 25, you hold $50,000 on average, you work until age 65, and you experience returns of 7% nominal and 5% real, you’re looking at an additional $700,000 nominal and $300,000 real. since this is “extra money” relative to the base case and assuming you don’t spend more because you have this “extra money”, assuming you live to age 85, this is $2.85M nominal and $870,000 real that your kids won’t see. i don’t know too many 85 year olds whose net worth is such that $870,000 is not a meaningful portion of their liquid net worth.
edit. haha. you beat me to the calc but there is a little more to it than you conclude.