Earlier this week, my wife got an email from the state dental association asking dental offices to shut down until the end of the month for non-emergency dental care. It’s technically not mandated, but like many of us going through the current Coronavirus pandemic, we’re doing our part to limit the spread of this virus via social distancing.
On a practical level, what this means is that my wife’s practice is closed for at least the next two weeks – and perhaps longer depending on how this pandemic plays out. That means she has no income coming in from her business, which means no income for her or for her employees.
It’s during times like these that you can see why a strong emergency fund has value. When things are going well, it can often feel like income and money are never-ending. You might even start to think that you don’t need any spare cash at all.
But when times are bad, you can see just how quickly income can disappear – and often in unexpected ways. With this pandemic shutting down businesses for an unknown length of time, having cash (or a way to get cash, at a minimum) is likely going to be more important than ever.
Your Emergency Fund Is Based On Your Risk Tolerance
Luckily for us, we’ve been planning for a moment like this for a long time. Over the past year or so, we’ve built our emergency fund to a point that it could likely last us a year or more. And due to some other strategies that we’ve been implementing, we have even more cash saved that could last us even longer.
To be sure, holding a significant amount in cash isn’t optimal from a pure numbers standpoint – there’s a real cost to holding cash. But it’s important to remember that money isn’t just about numbers. It’s about personal preferences and what makes you comfortable based on your own situation. A lot of people get so hung up on numbers, but the truth is, keeping money in an emergency fund is not going to be the reason you can’t reach financial independence. If you can’t reach financial independence, it’s going to be because you didn’t make enough or you didn’t save enough or because other unfortunate things held you back.
For myself, keeping all of this cash has to do with my own risk tolerance and the life circumstances my wife and I are in. We’re both business owners, which means that our income can fluctuate depending on how hard we work and how things are going in the economy.
My own experience has also taught me that income is never guaranteed and, importantly, it doesn’t always go up. If anything, your income can act a lot like how the market acts – it can go up and it can go down.
Take my own example to understand just how much income can change and why I view spare cash the way I do. When I made the switch from biglaw to state government, I ended up taking a $50,000 pay cut in order to make that move. And when I moved from my state government job to a non-profit job, I took another $20,000 pay cut. Because of how I view income – as something that doesn’t always go up – I’ve always felt more comfortable keeping a steady amount of cash on hand to ride the waves.
There’s sort of an interesting dichotomy here with my risk tolerance. On the one hand, it’s pretty low since I like keeping a lot of cash readily available. And yet, on the other hand, my risk tolerance is pretty high. All of my invested money is in 100% equities and I plan to keep it that way for a long time. And unlike most people, I took a risk and straight-up quit my job in order to try my hand at self-employment and side hustling.
With my high-risk tolerance when it comes to careers and investing, maybe it makes sense to have a lower risk tolerance when it comes to emergency fund money.
The Opportunity Cost Problem (And How I Address It)
Of course, the problem with holding too much cash is that it comes at a cost – that is, every dollar that you have saved in a bank account is a dollar that isn’t invested. Over the long run, that can cost you a lot in potential gains. To see how much it costs, simply take how much you have in your emergency fund and compare it to what it might be worth if invested in the market. The longer the time period, the higher the opportunity cost of keeping money in cash.
Cash sitting in a bank account also has the problem of losing money due to inflation. It’s one of the reasons why we have to invest our money. Because if we don’t, our money actually loses buying power. Like with any compound interest type problem, the longer the time period, the bigger the cost.
I definitely understand this opportunity cost problem, which is why I take so many steps to reduce the impact of opportunity cost, giving myself the highest rate of return I can on my cash with no risk of loss. I do this by maxing out all of the 5% interest savings accounts that I can, as well as taking advantage of bank account bonuses in order to get even higher rates of return. By doing this, my entire emergency fund is able to earn 5% or more interest per year. Most of my remaining idle cash is also able to earn effective annualized rates of return of 5% or more as well (by tying up money in bank account bonuses, for example).
It obviously takes work for me to do all of this stuff with my extra cash. The way I see it though, it basically allows me to turn my emergency fund into a sort of bond allocation to my portfolio. I get the best of all worlds, with cash on hand to match my risk tolerance and cover down periods, as well as minimizing the impact of opportunity cost from keeping so much cash on hand.
Keeping Different Levels Of Emergency Funds
A situation like we’re in now is exactly why a decent cash allocation makes sense to me. We have no idea how long this pandemic situation will last. I think many of us have this idea that it’ll probably only last a short while, but we really don’t know. It could last much longer than we think. And if you’re one of the people out there that are furloughed because of the type of job or business that you have, you’re going to need cash to hold you over – for potentially a long time.
That’s why it helps to have as many types of cash or cash equivalents to cover you in dramatic situations. Here are some of the many ways I have cash or access to cash with an emphasis on getting the most bang for my buck.
5% Interest Savings Accounts. I have a large sum of money sitting in FDIC insured bank accounts currently earning 5% or more interest per year. These are the accounts I have through Netspend, Insight, and DCU. These 5% interest accounts have been around for about a decade now, even when rates were very low, so I’m fairly confident they’ll continue to stick around, especially since not that many people take advantage of these accounts. You can read about how I set this system up in my Netspend post.
2.5% Interest Via Public. Public is a stock trading app that allows you to buy and sell stocks commission-free. More interesting to me is how Public offers 2.5% interest on any uninvested cash that you have sitting in your Public account. You’re limited to 2.5% interest on up to $10,000 per account, but that’s still an easy place to throw down $10,000 and forget about it. The cash in your Public account is SIPC insured, which means that if something happens to this company, your cash is still safe. Obviously, with fed rates dropping to 0%, there’s no guarantee that this interest rate will continue, but for now, I’m taking advantage of it while I can. (If you use my referral link for Public, you also get a free stock, so there’s another reason to open an account)
Side Hustle Emergency Fund. I’m not side hustling very much during this pandemic since I’m trying to exercise social distancing, but at the same time, it’s good to know that, if necessary, I have a lot of on-demand side hustles that I can turn to if I’m in a pinch. This is the concept of the side hustle emergency fund – a plethora of gig economy apps that I can use to generate some revenue.
Making Use Of The Assets Around My House. I recently reread The Life-Changing Magic of Tidying Up, which has put me in a bit of a cleaning frenzy. One thing it has gotten me to do is to clear out my closet of all of the clothes I don’t wear. I discovered I have hundreds of dollars worth of clothes that have just been sitting in closets and drawers (to get a sense of how little I wore some of these clothes, I found a note in one of my suit jacket pockets from four years ago, which means I haven’t worn that suit jacket in four years). I’ve listed up all of this stuff on eBay now. My guess is that if you look around your house, you might find hundreds or thousands of dollars worth of stuff that you literally do not use.
Credit Card Points. I currently have thousands of dollars worth of credit card points and miles. Some of these points and miles are limited to travel only. This still has value as part of my emergency fund, since it’s always possible that I need to travel somewhere on short notice. I also have a huge stockpile of Chase Ultimate Rewards Points that I could redeem as a statement credit. This makes these points a potential cash equivalent if I need to dip into them.
A Strategy If You’re Paying Off Debt. A final strategy I’ve implemented over the past year applies to those of you that are currently paying off student loans. My wife still has a decent chunk of dental school student loans. Because of current life circumstances, we’ve been paying minimums on her student loans and stockpiling all of the excess money that we would have paid towards her debt into a side fund. The idea is that at some point, the money we put to the side will be enough to fully pay off her student loans. We do lose a bit in terms of the interest we’re paying on her debt, but since our time period is short (only a year or two), the cost isn’t that significant. If we need to, we could dig into this cash and honestly live for years.