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Rainy Day Fund


matjone
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  A lot of personal finance advice says to keep 6 months or a year's expenses in savings.  I remember tweedy browne saying to keep 3 years worth - their reasoning was that 3 yrs was an a typical time frame for undervalued stocks to recover, so you would most likely never have to sell stocks at a loss to cover expenses in the event of job loss, etc.

 

Have you always followed this advice, especially in your early years?  To what extent?  I come pretty close to the 3 year rule (I have probably 30k expenses and keep about half of my 160k of funds in cash, other half in stocks), but sometimes I think that it is excessively conservative and I am just making myself poorer over time by keeping this money earning the currently pitiful return on cash.

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  A lot of personal finance advice says to keep 6 months or a year's expenses in savings.  I remember tweedy browne saying to keep 3 years worth - their reasoning was that 3 yrs was an a typical time frame for undervalued stocks to recover, so you would most likely never have to sell stocks at a loss to cover expenses in the event of job loss, etc.

 

Have you always followed this advice, especially in your early years?  To what extent?  I come pretty close to the 3 year rule (I have probably 30k expenses and keep about half of my 160k of funds in cash, other half in stocks), but sometimes I think that it is excessively conservative and I am just making myself poorer over time by keeping this money earning the currently pitiful return on cash.

 

6 months rule of thumb is more applicable to people who are at the accumulation stage of their life and 3 year rule of thumb is for those who are closer to retirement. 6 months expenses is for getting through to the next job if you lose the current one. 3 year expenses is to ensure that in retirement you are not liquidating your investments when they are down.

 

I personally prefer to squirrel away a few years expenses in inflation protected securities (I-Bonds accumulated at a time when they are offering 3.6%, 3% and 2% real returns - around 6-7% nominal currently - and limits are $60k per annum per family member). I learned to live with these returns and not be too greedy for part of my portfolio.

 

Vinod

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I have always had the feeling that the three year rule seemed a little high for people who are getting started.  For someone fresh out of college earning 60k or so and living where i live they'd probably have to wait 2 years or more to even get started investing, which would probably make a huge difference in their eventual net worth.

 

I am thinking about reducing it down to 2 year's expenses.  One good thing about the rule is that you get to reward yourself for reducing your expenses - for every dollar you cut expenses you free up three dollars for investments.  Of course only a freak would consider that a reward.

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If you think it's complicated with just one person, imagine how complex it gets when you have a spouse and kids.  You really have to start modeling out scenarios.  What if I lose my job? What if my spouse?  What if we both lose our jobs?  Then there are the kids.  Losing a job would mean fewer daycare expenses.  Then under what scenario do you take the 6 month - 2 year fund?  Then you assign probabilities to the scenarios and their required funding requirements and come up with a number.  Kind of tricky since the best case scenario (6 months + lower income earner loses job) is an order of magnitude less than the worst case scenario (both lose our jobs + 2 years).  This is not a simple question at all unfortunately.

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I guess it is true, every situation is different.  I have this fear that as soon as I go down to 6 months expenses great depression #2 will come and I'll be living in a tent like Tom Joad.  You have to balance that with the risk of doing like buffett said and waiting for the crash that never comes.

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I keep my personal finances and investments separated.  So for me at this point my investments don't provide any income, it gets reinvested.  This also means I don't count any investment cash as emergency fund cash or anything, although if dire straits came I could liquidate my portfolio and last a while.

 

So we aim for 6 months of expenses in cash and keep it in a bank account at a different institution from our investments.  This covers things like a big house emergency like a sewer backup with $10k of damage, to losing a job and needing to buy food for a few months.

 

I figured our savings needed by doing the following.  I took our monthly budget and eliminated things we wouldn't do in a job loss situation such as stashing away cash for a car purchase.  Then I took that core amount and multiplied by 6 and we saved that amount.  Sometimes it's nice to have an extra cushion with a life change like moving or having children, even if you don't use it you have that padding available.

 

If I was going to live off my portfolio I think three years would be a good goal, that and a paid off house.  I think those two together would eliminate a lot of the stress that might go with needing to generate an income, plus without a mortgage the expenses required should be a lot less.

 

I am a big fan of de-risking my life, low/no debt, having savings and keeping expenses low.  I guess I take the old man approach to life, try to be prudent in our finances.  This approach isn't for everyone, there are a lot of wealthy people on this board and if you have millions it probably doesn't matter if you have a mortgage or watch what you spend.  I am not wealthy, doubt I ever will be, so I take the old fashioned view on personal finances.

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Yeah I do too.  But I sometimes think about what Buffett would do -    I don't get the impression he ever kept much in savings until he got rich.

 

Hopefully you're wrong on your prediction about not getting wealthy.

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