Where to park short-term excess cash?

I advocate that an emergency fund is not needed these days. I'd suggest fully investing your money to make it work as hard as it can. For emergencies, first, try to avoid them. But since not all are avoidable, have a credit card or a home equity line of credit available (ie, in place before it is needed). Then use your earning power to rapidly pay it back in the event it is ever used. If you are one of those folks who misbehave with credit, then this would be a bad idea, and the cash emergency fund is the best way to go.

-john-

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John A. Weeks III wrote:

I tend to agree, John. If one has credit card debt they pay interest on, the 'emergency fund' is costing them up to 15%/yr. (differ between high interest card and current CD). I've advised people who are sitting on $5K, but with that kind of debt to just pay it off. They can always take a cash withdrawal if a true emergency came up. And by making the same monthly payment before the big pay-down, they can quickly become debt free altogether. And for debt-free savers, the use of the 401(k) capturing any match, can serve as emergency more, as the loans are low interest and easy to get. JOE

snip for conciseness

Joe, your site

prioritizes having an emergency fund over paying off debt: "The first rule is to protect yourself from ruin," etc. You have also indicated that people should not necessarily invest in a 401(k) beyond the matching, whereas the OP says he's maxing out his 401(k). Does your post above mean you have changed your mind on these two points?

You caught me a bit out of context. On my Suze comment, she was advising a caller to pay off a car loan. My remarks there were strictly to offer the choice between (a) pay off loan, no money in bank or (b) maintain the loan and have cash on hand. The car loan was low interest and not something the caller could just get back if the cash were needed. I did say there was limited information regarding the caller, if I knew she had a 401(k) with a good balance, or other available credit, my comments would have changed.

Investing in one's 401(k) beyond the match comes down to three variables:

1) Expense within the 401(k) (of course, compared to expenses outside) 2) Possible large shifts in tax bracket from pre to post retirement. 3) Amount of high interest debt, or other needs for external liquidity. (I miss anything else here?)

I am running spreadsheets and planned to post a page discussing the

401(k) expenses and impact on savings in my January blog. As always, I appreciate your advice and attempts to keep me honest. JOE

For beginning savers with lots of debt, living paycheck to paycheck, an emergency could mean an expensive late charge, payday loan, or credit card interest. On top of that the mean time to find a new job can be several months at low end and more at the high end. Then a couple months of living expenses saved can be very useful.

For people who have a lot savings- more than a year of income, a few months expenses in a highly liquid bank account is more of a "convenience account" to accomplish the same things- avoid late charges, avoid paying any interest, avoid causing a taxable event by selling an gain investment. The amount of return on the convenience fund is not that super important to bottom line when all savings and investments are totalled.

You said in your previous post to just let one's credit card be one's emergency fund. AFAIC, this differs significantly from the counsel you give at your site. I do not think there's anything out of context at all. Or, if there is, then maybe you should consider showing the same generosity towards other financial advisors that you imply I should show towards your posts and web site in this thread. Namely, there are limits as to how much one can say in a sound bite medium. Instead, one should read all of what the financial advisor (amateur or professional) has to say on a subject.

It's also important to have good investment options in the 401(k).

There is also a need to protect one's wealth from legal liabilities.

Yes, thanks. I made a bad assumption, that low expenses were enough. The fund choices better be good as well. And the protection aspect is noted. I am told that the protection may apply to annuities as well, but haven't found solid information in that regard. If so, I may consider that the 0.25% (for the low cost annuities) or an incremental cost of

0.25% within a 401(k) can have that value. JOE

One more thing - putting money into a 401k reduces one's AGI - which can help make one eligible for other things - including Roth IRAs - for folks who are creeping up at some of those cutoffs. There are other deductions which come out *after* the AGI calculation and which therefore don't help in this regard (ie. mortgage interest, charitable contributions, etc).

I said; If one has credit card debt they pay interest on, the 'emergency fund' is costing them up to 15%/yr. (difference between high interest card and current CD).

In the strict context of knowing the OP had the 401(k) all set, I stick with above. This is in the interest of brevity, otherwise I'd have disclaimer after caveat, after question.

The point is taken, mostly. The difference to me is that here, it's understood there's a chance for follow up questions and clarification. I am considering taking down the remarks on others' advice which I consider unsound, as it's becoming a distraction of late.

I fully agree that it is better to have some cash -even at the cost of holding some debt, which is more costly- than no cash at all and little debt. The self-insurance benefit derived from holding cash balances is higher than the opportunity cost of cash over debt. It is a well-known fact that most company bankruptcies come from short-term liquidity constraints, not because of a solvency problem (although, of course, solvency and liquidity problems are closely correlated).

The > Elle wrote:

======================================= MODERATOR'S COMMENT: Please trim the post to which you are responding. "Trim" means that except for a FEW lines to add context, the previous post is deleted.

What happens under your no emergency fund strategy if the emergency is one or all household wage earner's losing their job or becoming disabled? Then there is not necessarily enough earning power to rapidly pay back the amounts borrowed on credit cards.

Also, many credit cards now have universal default provisions, and in the event of disability or losing a job a household could find themselves missing some bills and then having the credit cards they are depending on increase their rates.

Andy

This is where my plan really shines. You simply cash out the investments, and use that money to repay the loans. Since you invested the money in good funds rather than stuffing it in a mattress, you should have far more money in those investments now than had you kept it in a mattress. It leaves you in a better financial position when you get layed off. Since you are using credit for the emergency fund, you are not under pressure to cash out on a given day, so you can time the market or wait out a down turn, which helps avoid the risks of an investment downturn.

The lesson is to not miss any bills. That is why you want some quick credit available, and the investments to pay off the credit balance. The trick is to get the credit account established before you need it, so you get a good rate based on your good job, not a high risk rate based on being unemployed.

-john-

Andy, since, as with most questions here, the answer would often differ based on information we know about the OP, but change for a different poster, I have a question in turn. Do you (and others) feel that the emergency fund is always indicated? I can tell you when I think it is, so that even though I agreed with John's remark that it's not, of course there are those that should have one. [I took John's 'not' to be a generalization good for 80%, not an absolute good for 100%]. Someone who for whatever reason has no source of tappable cash they could raise at a reasonable rate in a reasonable amount of time.

Someone at the lower end of income would be better served by making

401(k) deposits to capture the match, if this is an option. The perhaps $5000 they maintain in an emergency fund can morph into $8800 between the tax effect at 15% marginal rate and a 50% match. Now, I view this as $8800 they can borrow if the transmission goes, or some other unexpected expense hits them. If they lose their job, and fall into the zero percent bracket, they owe $880 in early withdrawal penalty, and are still ahead.

In the middle, someone with a 20% interest credit card would save 15%, the difference between the card rate and the saving rate. $750 in interest charges isn't a small amount for them. Yes, I need to be sensitive to the risk they'd have to borrow it back, yet I still don't see how if they lost their job a year hence that they'd be worse off borrowing back that same money.

At the high end, the OP of this thread is max'ing his and the missus

401(k) so it seems that they have that to borrow against. The thread quickly turned to 'no emergency fund needed' so we never asked how high the mortgage interest rate is. Maybe paying some principal and pulling in the term as well should be advised. I think that as one's income and assets go up, the desire for emergency funds would diminish. I do think that for others it's a bit counter-intuitive.

About 4 years ago, I came to this conclusion, and proceeded to take the liquid/emergency savings, then earning barely 1%, refinanced the mortgage, reducing the rate to 5.25% and the term from 20 years to 15. At the same time, I opened up an equity line. I felt the risk of having to borrow against it was low enough, and the interest saved was money in our pocket that I was comfortable doing this. I know that this approach is not for everyone.

JOE