Maintaining value of your emergency Fund

bowlhead99

DireEmblem said:

So my thoughts are - what if I put part of my emergency fund into a cheap global equity fund.  The FTSE All world Index has returned an average of 8.1% since 2005.  All things being the same, if I were to deposit a months emergency fund into a FTSE All world tracker fund, then long term, this could in effect increase the 0.75% by 1.225% ((8.1%-0.75%)/ 6) to 1.925%.

Here's FTSE's own factsheet for FTSE All World index, from three years ago (so that the ten-year data includes the 2007-9 global financial crisis):
https://research.ftserussell.com/Analytics/FactSheets/Home/DownloadSingleIssueByDate?IssueName=AWORLDS&IssueDate=20170929&IsManual=false
It shows a nice annualised ten year return, which in dollars was almost 10% per year at the date of the statement.

However, the third table on the front page shows that the biggest 'drawdown' (fall from peak to trough based on daily prices) was 57.9%. That was over about an 18-month period from late 2007 to early 2009.

As it happened, sterling weakened against dollars at the time so investing from the UK the fall was not as significant as it was for the Americans however there's no saying that 'next time' sterling wouldn't strengthen or stay the same. So 50-60% loss over a one to two year period couldn't be unexpected by any investor in that index, as we've literally seen it happen before (either in person, or just from looking at the factsheet). 

If you have money in an 'emergency fund' because you might need it in an emergency, and then you go to grab it to help you get through the emergency and it's lost half (or more) of its value and you have to cash-in that huge loss to make ends meet, you may be feeling pretty dissatisfied with the way you chose to save up for the emergency. Of course, you might get lucky and have the good years first, so that you can afford the loss.  But it seems to me that putting money away 'in case of an emergency' does not involve putting it in something with 10%+  long term annualised volatility that can lose half its value in a short space of time. 

If you have (e.g.) a "6-months' expenses" emergency fund but the last month of it is in equity based investments, you are really just saying you have a five month emergency fund and if your emergency is the size of six months' expenses instead of the five that you're prepared for, you will raid your long term investments and take whatever gain or loss is necessary to get you through the emergency.

Some people will be quite happy with five months' emergency fund if they have a bunch of space on credit cards and are willing to break their long term investment objectives and take losses to help fund a short term problem.  Other people would be more conservative. 

 If you lose your job and have an accident that prevents you getting new work easily (or the economy is in the toilet and nobody's hiring) at the same time as the boiler breaks down and you need a new car or new roof, and you can't take a loan or new credit cards because you're not in employment, and the mortgage or rent can't be paid from credit cards anyway, a few months of cash could be burned through very quickly.

By contrast, if you have a partner who's also in gainful employment and you can get by on just one of the salaries, or are not embarrassed to ask for a short term loan from friends or family, you might find that 'emergency' day never comes and it would have been better to put more spare money into long term investments.  So, everyone is different with their attitude to 'emergency funds' and some don't have one at all, preferring to 'get by' some other way.  But as this is a 'money saving' site, people tend to be conservative and have a bigger/ better emergency fund than the general population, and generally see 'savings' vs 'investments' as different topics without blurring the objectives of each.  But it's natural for the two things to get a bit blurred when people look at 'what is my net worth' and 'how can I get all my assets working for me'.

London7766551

I have my entire yearly salary saved and more, however this is more for a house deposit but could be used in emergency. In a mix of LISA, PBs, and other savers. I did consider having a couple of thousand in cash at home but decided against it. When I buy a house I won't having anything at all and will start again. 

DireEmblem

London7766551 said:

I have my entire yearly salary saved and more, however this is more for a house deposit but could be used in emergency. In a mix of LISA, PBs, and other savers. I did consider having a couple of thousand in cash at home but decided against it. When I buy a house I won't having anything at all and will start again. 

Is that wise - surely a small buffer in case of unknown bills?

stephenadarglas

DireEmblem said:

London7766551 said:

I have my entire yearly salary saved and more, however this is more for a house deposit but could be used in emergency. In a mix of LISA, PBs, and other savers. I did consider having a couple of thousand in cash at home but decided against it. When I buy a house I won't having anything at all and will start again. 

Is that wise - surely a small buffer in case of unknown bills?

The Premium Bonds will serve that purpose.