At least partly. A nest egg, Getquin-style.
tl;dr
Common online recommendations for emergency funds (1–6 months’ salary, all strictly in a checking account or money market fund) are flawed and not return-oriented. Your emergency fund should be calculated based on your expenses, not your income. Once your investment portfolio reaches a certain size and with a sensible investment strategy, part of your emergency fund can be invested.
It’s time once again to challenge common recommendations online. Today: the emergency fund. Since many people unfortunately still lump regular planned expenses, vacation funds, and the emergency fund into one category, I’ll start with the basics:
The emergency fund consists of reserves for absolute emergencies. For example, for urgent, unplanned expenses that come due at short notice and cannot be postponed under any circumstances. It also includes reserves to cover the most essential recurring expenses should a source of income dry up.
The emergency fund should be kept separate from regular planned expenses such as rent, groceries, hobbies, etc. The money needed for these (+ a buffer) should always be in your checking account and does not count toward the emergency fund. The same applies to money that is planned to be spent in the foreseeable future. For example, for a new smartphone or a vacation. Ideally, the necessary savings for these are kept in a money market account and are also not part of the emergency fund. Or is going on vacation an emergency?
Now that that’s clear, let’s turn to the size of the emergency fund and thus one of the questionable “expert recommendations” online: Your emergency fund should be set aside in the amount of 2–3 (or, depending on the source, 1–3, 2–4, 3–6, ...) months’ salary (either gross or net).
Why do the figures vary so much? Because they’re nonsense. Based on the fundamentals of an emergency fund mentioned at the beginning, it’s not helpful to set a blanket figure of 1–6 months’ salary. It’s not the income situation that needs to be considered, but the spending situation. A low-income earner who rents, drives a 20-year-old car, relies on it, and is frequently absent from work for extended periods due to health issues needs a larger emergency fund than a top earner who lives rent-free in the basement of their parents’ paid-off single-family home and works 100% from home.
When determining the size of the emergency fund, options that alleviate the financial burden of an emergency should also be considered:
- Instead of repairing the car immediately, I’ll use public transportation for a while
- If I get laid off, it won’t happen overnight, and there’s unemployment insurance
- I have insurance in case of disability
- ...
To determine a reasonable amount for your emergency fund, look at your recurring, non-negotiable expenses and combine them with potential unplanned expenses that cannot be offset or postponed.
And that brings us to the controversial part of this post: Your emergency fund should (partly) in your investment portfolio! Simply for the sake of returns.
Of course, not right from the start. Once all debts have been paid off, the next step is to build up an appropriate emergency fund before considering investments in the stock market. But once the emergency fund is built up, you’ve started investing in the stock market, and your portfolio is worth many times the size of the emergency fund, you can certainly start putting parts of the emergency fund into your portfolio as well. Or to put it another way: You can reduce the size of your emergency fund. At least, if you’re following a reasonably responsible investment strategy (e.g., global ETF) and your portfolio isn’t made up solely of reckless speculative plays.
Why is this possible? Because your investment account serves as an additional safety net. You no longer need to keep as much cash on hand for emergencies, since you can withdraw funds from your investment account relatively quickly. Yes, even your well-diversified global portfolio can crash. But it definitely won’t drop to zero. And if it does, your emergency fund in your checking account will likely be worthless too.
The larger your portfolio, the more you can reduce your emergency fund and thus benefit from stock market returns. Keep in mind the time it takes for your money to reach your account after you sell. This often takes days. Accordingly, I would always keep a portion of your emergency fund in a checking account or money market account. Even though there are likely very few emergencies in which you’ll actually need money immediately:
- Getting laid off won’t put you out on the street overnight
- In the event of a serious illness, your wages will continue to be paid for several weeks
- If your car breaks down, it gets repaired and only then is the bill paid
- If the washing machine breaks down, you can go without doing laundry for 2 or 3 days, use your neighbor’s machine, or go to a laundromat
- ...
In addition, genuine, free credit cards offer you additional ways to access money quickly and without fees. For me, it therefore makes perfect sense to put up to 50% of your emergency fund into a stock portfolio—as soon as it’s large enough.
How might your emergency fund grow over time?
You decide how large your emergency fund should actually be. Once you’ve paid off all your consumer debt, you build up the emergency fund to your target amount (checking account or money market account). Important: You do not use your emergency fund to pay for your regular expenses or vacations. That is handled separately. After that, you turn your attention to your investment portfolio. For example, you could transfer 500–1,000 euros from your emergency fund to your investment portfolio for every 10,000 euros in a global ETF. You do this as long as you feel comfortable with it.
Conclusion
General recommendations online definitely have their place. They’re easy to understand, easy to implement, and thus a good starting point for people who aren’t interested in the topic. But here at getquin, we’re in a bubble. We love diving into finance and squeezing out even higher returns while keeping risk reasonable. So why not do the same with your emergency fund?
How much is your emergency fund, and do you keep it (entirely) in a checking or money market account?
Kisses to your portfolio 💋
Your Christmas Donkey
