Conventional personal finance wisdom says that it’s essential to have a designated emergency fund. The typical suggestion is that your emergency fund should be a checking, savings, or money market account with 3-12 months of living expenses in it.
But is there a point at which there’s no need to keep a separate emergency fund? That is, is there a point at which your retirement portfolio (and other assets) can do double duty as your emergency fund?
I think there is. If your retirement portfolio is large enough, liquid enough, and accessible without adverse tax consequences, you don’t necessarily need a separate emergency fund.
Is Your Portfolio Large Enough?
In order to be able to safely do away with your emergency fund, you have to know that, in the event of an emergency, your portfolio would be large enough to satisfy any immediate, short-term spending needs.
Whether or not it can do that depends on the size of your portfolio, your asset allocation, and the size of any potential unplanned spending needs.
For example, if your stock holdings declined by 50% over the next year, and at the end of that year you got laid off or found out you needed a major home repair, how problematic would it be? The more problematic such a scenario would be, the greater your need for an emergency fund.
Are Your Assets Liquid Enough?
In order to live safely without an emergency fund, you also have to know that you can turn your assets into spendable cash in a short period of time.
For example, if you place a sell order for one of the holdings in your brokerage account, you should be able to have the money in your bank account within just a few business days. For most unexpected spending needs, that should be just fine.
In contrast, if most of your net worth is tied up in something significantly less liquid (real estate or a lifetime annuity, for example), you probably need an emergency fund.
Tax Considerations
Finally, in order for it to make sense to do away with your emergency fund, you need to be able to get to your money without adverse tax consequences. If you’re under age 59½, you would want to make sure you have sufficient Roth IRA contributions (which can be withdrawn free from tax or penalty at any time) or sufficient holdings in taxable accounts (without large unrealized capital gains) to satisfy any unexpected spending needs.
Obvious Exception
As with most personal finance concepts, the above discussion comes with some exceptions. Most importantly, if you know you’re not going to be able to sleep at night without a certain-size pile of cash in your checking account, the question of whether or not you need an emergency fund pretty much settles itself.
Hi. I'm Mike Piper, the author of this blog. I'm 
I keep my emergency fund split up. I currently have 4 months expenses in cash, and 3 months expenses in company stock through my ESPP. I also treat my Roth as my back up emergency fund which I would not want to touch unless a HUGE emergency. That has another 7 months work of expenses. I’m young so no where near 59 1/2 so the 401k and Rollover IRA are untouchable.
A portfolio of sufficient size and composition can certainly eliminate the need for a separate emergency fund. In our retirement portfolio allocations, we take into account the amount needed for an emergency fund and ensure that our subscribers don’t put too much into riskier asset classes such as stocks or bonds. Though we did this to address the common problem of folks investing before having the needed cash reserves on hand, it works the same way that you’ve alluded to here.
One of the major causes of investors buying high and selling low during volatile periods goes back to the reality that too many folks haven’t properly addressed their rainy day funds. This reduces their ability to remain confident in their long-term investment strategy because short-term shocks can up end anyone’s finances that doesn’t have enough in cash. If, as you pointed out in your post, the worst case scenario comes to fruition through a market meltdown and subsequent job loss, those that have a healthy separate emergency fund or an appropriate cash allocation in longer term savings such as retirement will be in a much stronger position.
Mike,
If plan to use your portfolio as an emergency fund would you allocate some % in cash equivalents to handle emergencies even when the market is down, or stick bonds take the likely higher gains?
I think it would be a good idea to keep a reasonable cash buffer – at least $1000 outside the portfolio just to minimize how often you have to dip into the portfolio and provide a buffer for variation in monthly expenses.
-Rick
Hi Rick.
I guess I would consider allocating a not-less-than-$x portion of your portfolio to cash to be the same as having an emergency fund. In other words, yes, it makes sense to do that if the potential size of an unexpected spending need is high in comparison to the size of your portfolio (or more specifically, to the size of your portfolio in the event of a severe bear market).
In contrast, somebody already retired, with good insurance, and with a very large portfolio, probably doesn’t need to worry about it.
Some people may be dipping into their emergency funds in the near future if Congress doesn’t come up with a way to raise the debt ceiling. The reality is that most people do not have any kind of emergency or reserve fund to fall back on.
Interesting that you list a Roth account as a possible emergency fund. A Roth, like all other retirement accounts should be first and foremost a retirement account. But it could work very well as an emergency fund, since as you wrote, your contributions can be withdrawn without tax consequences even before turning 59 1/2.
Meanwhile you can earn income on the account and let it compound tax free. That would really maximize the return on an emergency fund.
I agree with Kevin, in that a Roth is kind of a two-edged sword: you can withdraw your after-tax contributions from it any time, but you can also leave it alone to grow tax-free. For this reason, I was advised several times that ideally the Roth should be the last account to dip into. But I know it’s there if I had no alternative, and at age 63 I can take out any or all of it with no tax consequences. Having opened my Roth about 10-12 years ago, however, I haven’t yet found any expenses that I couldn’t meet by other means.
I love that someone is bringing up the fact that Roth IRA’s can be used as an emergency fund/short term savings vehicle. It seems like so many blogs miss this. If at the end of the tax year you haven’t hit your max contribution on your Roth IRA and you have a decent cash emergency fund, why not put that into the Roth? You can put the funds into cd’s or some similar ultra low risk asset and you can always pull it out if you truly need it. If you don’t need it, down the road you can allocate it into a riskier/higher return investment and you’ve got a larger tax-advantaged balance than you would otherwise. Seems like a no-brainer.
I do think it can be a good idea to put money into a Roth IRA that you think you might not be able to afford if an emergency came up. Then if there’s an emergency, you still have the money, but if there’s no emergency, there you are with a bigger retirement fund than you otherwise would have had.
Mostly, though, I think people with enough retirement money to not need an emergency fund would have no trouble also having an emergency fund.
Finally, I personally do better splitting up my money into categories to a) help me save money for various things that I want and b) help me spend saved money guilt-free if I’m spending it on something it was deliberately saved for. This means I do better separating my emergency fund from my retirement funds.
I’m not totally inflexible–I did steal (ahem, reallocate) money from other funds to get a newer car than expected. Then I borrowed from another fund to pay off next year’s vacation quicker (tickets were cheaper when paid for up front rather than in installments).
“Mostly, though, I think people with enough retirement money to not need an emergency fund would have no trouble also having an emergency fund.”
This is a good point. 🙂
I hadn’t meant to give the impression that it’s imperative for somebody to get rid of their emergency fund if they’re able to do so safely. Rather, I just meant that, for some people, there’s really no need to worry about it either way.