My meagre emergency fund aside, I don’t hold any cash in my portfolio. Why meagre, you ask? Because I raided it in March for some extra pension contributions, and have not yet replenished it. Because: life keeps getting in the way.
Not having enough cash in the emergency stash leaves one exposed, and in that sense I’m riding a riskier position than I’d like to. There are mitigating factors, but overall I know that I’m doing this thing wrong.
How much is enough?
In yachting, they say that if you think you’re carrying too much sail, then you are carrying too much sail. This applies to personal finance, too: if you’re not entirely comfortable with the amount of risk you’re taking, then you are taking too much risk. If you think that your emergency fund is too small, then it is.
My ideal balance is around £30k. At the moment I’m about £19k short. And I just bought another watch. Also, having 14 days of annual leave remaining to use or lose this year, I booked a holiday, and it’s more expensive than I had budgeted for. So next month I’ll be £25k short. I guess that’s the piss poor planning part.
The £30k isn’t my 6 months’ worth of outgoings, or 9 months, or 12, or whatever. It is the amount of money that I want to have in my (numerous 😉 ) bank and savings accounts in order to feel financially safe-ish. If I lost my job, or had to take a career break for family reasons, £30k would allow me to get through that without having to stop every 5 minutes to hyperventilate into a paper bag.
I could take holidays without feeling guilty about it.
Reasons and excuses
Poor planning of purchases aside, the main reason for not topping up my Emergency Fund post haste is, basically, greed.
Not having enough emergency cash stashed away is a risk, but so is inflation. I realise we’re talking opportunity cost here and relatively small amounts at that – inflation will erode the real value of my emergency fund at the same rate it erodes my mortgage balance – but I’m a sucker for regret.
I don’t know if the market is going to be up or down next month or next year, nor do I know what is going to happen to the pound. However, shovelling money into a SIPP gives me a 40% to 60% uplift on my money, which goes some way to compensate for any pending market crashes. The are no tax breaks for holding readily accessible cash in a bank.
I am also trying to limit the incoming damage from Brexit by reducing my exposure to the pound. The idea of keeping £30k in GBP cash in a low interest savings account does not fill me with excitement. Does it have to be GBP cash? The short answer is yes. The long answer is yes, because my emergency fund is not the place where I want to see any volatility whatsoever, be it market price or currency volatility. I expect we’ll see quite a lot of volatility in exchange rates over the next few years.
The thing is, these are all mainly excuses.
Liquidity has a cost, and in the scheme of things this cost is not that high, really. On the other hand, the amount of risk I am taking by not holding the amount of liquid funds I believe I should hold is unquantified. It could be anything from paying a 21% interest on my credit card balance for a few months to a repossession or a forced sale of my home.
Taking unquantified risks in exchange for peanuts is a rookie’s mistake. I should know better. So I’ll start replenishing my Fund for Emergencies and Piss Poor Planning ASAP, by which I mean in November, when I’m back from holidays 😉
In case of emergency break glass
The internet is full of advice for determining the correct size of one’s emergency fund. I think it’s more art than science. Anyway, here’s my recipe:
- Imagine you lose your job, and there’s maybe a small recession going on.
- Imagine the market is experiencing a dip too, so that selling any of your investments would crystallise losses, say to the tune of 20%.
- Do you have any other sources of income? A lodger, for instance, or a dividend from SAYE shares? That’s good, don’t forget to take this into account.
- What’s your notice period? If you get sacked your employer will likely pay you your notice, or you’ll have more (paid) time to look for a new job.
- What’s your single largest financial commitment? For me it’s a mortgage. Is it flexible (i.e. could you use any previous overpayments to temporarily reduce your minimum monthly payments)?
- Now, how much money do you need to have in a bank in order to remain sane until you secure decent alternative employment? By decent I mean something that perhaps is not your dream job, but is also not something that’ll kill your soul and any remaining self esteem in two years flat. Let’s call this number an [A], which in my case is £30k.
- What is your second largest contingency? In my case, it’s replacing the boiler. But if I lived out in the sticks and couldn’t do without a car for longer than a week, that would be the amount I (as opposed to the insurance company) would have to pay for a significant repair if I had an accident that was my fault. That will be a [B], which for me is £4k.
- How much cash do you need to have on hand to compensate for occasional episodes of poor planning and an lapses in financial discipline? Let’s call this a [C], and in my case it is £5k.
- My emergency fund is = SQRT ( [A]^2 + [B]^2 + [C]^2 ), and it works out to £30,676.
- Well, at least I didn’t have to borrow to pay for it. And at least I haven’t gone and done something even more stupid, like borrow to buy a boat. After all, if you want a Rolex, it’s much cheaper to just buy it rather than trying to win it every second year in the Swan Cup.
- I don’t think there’s a market wipe-out coming up. The QE changed the boundary conditions of stock indices; I have a feeling that a significant portion of the so-called market gains is merely asset price inflation cause by the monetary policy over the past 9 years.