Is an emergency fund a waste of time?
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If personal finance advice was a religion, setting aside three to six months of money in an emergency fund would be one of its key tenets. And in a recession, many financial advisers say to save enough to cover a year of expenses.
Karsten Jeske has gone his entire working life ignoring this advice. The 46-year-old retired two years ago after working as an economist in the financial industry.
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Rather than keeping money in a savings account, Jeske relied on different sources of emergency funding (laid out in detail on his blog, Early Retirement Now, including a credit card, a home equity line of credit, and as a last resort, withdrawals from brokerage accounts.
Jeske cites a basic economic principle when asked why he abstains from emergency funds: opportunity cost. These days a typical savings account earns almost nothing, while the S&P 500 was up almost 20% over the previous year at the end of August, despite the economy being in a recession.
Every dollar in a bank account could be earning more if it were in the stock market, Jeske reasons. That's why Jeske, who is part of the FIRE (financially independent, retire early) movement, has piled money into the stock market since the start of his career. This strategy has worked for Jeske, who met his goal of retiring early with a net worth solidly in the seven figures.
"Especially for younger people who are just starting out, get your money in the stock market as soon as possible," he said.
Money in the stock market isn't easy to pull out quickly if you get a big medical bill or your hot water heater goes out. Jeske's first step when he has an emergency expense is putting it on a credit card. When his next paycheck comes, he reduces the amount he'd normally put in the stock market and pays off the balance to avoid any interest payments. If the expense is bigger, Jeske relies on a home equity line of credit, which he also pays off by reducing his future investments.
Jeske's last resort is to sell off some of his investments. This is risky because the market could be down when an emergency takes place, leading to financial losses or, if the market is up, taxes.
But, Jeske reasons, true emergencies are rare enough to take this risk.
"You lose some, you win some," he said. "It all averages out. And if you look at this in the long term of long horizons and the big picture, I would still propose going without an emergency fund and just investing the money."
Most people won't be able to pull off having no emergency fund, said Bill Brancaccio, a certified financial planner and cofounder of Rightirement Wealth Partners. Not everyone has access to a HELOC or enough money in investments outside of retirement accounts.
Without these things, Brancaccio said, relying on a credit card could lead to rapidly growing interest payments.
Not everyone will be comfortable going without an easily accessible pot of money, said San Asato, a certified financial planner and managing adviser. Keeping a few months of expenses in a savings account shouldn't derail your long-term investment goals, he said.
"If that is going to crash your plan, then you have the wrong plan," Asato said.
Like many things in personal finance, the size and composition of your emergency savings depends on your circumstances. If you have low debt and a decent amount of money invested outside of a retirement account, it may be possible to pour all your savings into the stock market.
But, Brancaccio said, "If you only have retirement plan dollars saved, little equity in your home, a lot of debt already in place, or are self-employed you might not want to go this route."
Image: Vitaly Taranov (Unsplash)
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