Thoughts on holding EF in liquid investments

[IPAfan]

I've played around with investing EF money in securities within a taxable brokerage account when I've got what I consider to be an especially attractive investment opportunity with fairly limited downside. I certainly don't keep EF dollars invested at all times and usually keep cash instead. I have had the EF in cash for all of 2011.

I just transferred $5,500 to my taxable brokerage acct. (which is otherwise empty as my long term investments are all in the ROTH IRAs) I'm probably going to make an investment over the coming week. The problem with this type of financial engineering is that there's always the risk that the investment goes against me just when I need the money. This HAS happened to me in the past, and it sucks.

I've got available credit limits, and should be able to borrow short term at 0% (I've got a 747 FICO score and $1,100 total in debt right now).

I've seen Phil talk about keeping money invested in an index fund as an EF. Does anyone else consider liquid (but volatile) long term assets as appropriate for an EF?

[Havoc]

Well.... sort of.

We have a cash cushion of several months that we consider our EF, and then have an index stock fund that we add to that we also consider our long term EF... i.e., if TSTF and we were burning through our cash reserve, we could start to liquidate some or all of the mutual fund, but at least then wouldn't have to do it at the most inopportune moment.

We used to operate in the manner you've described - sometimes cash, but using it for an investment when the opportunity presented itself - but over time we've gotten burned enough times that we feel more comfortable having a certain amount of cash all the time... and then investing the remainder so that we don't feel like we have a large amount of sweat and tears losing value to inflation in a bank.

[sunuva]

My wife and I hold individual stocks in our EF (fully taxable account). But I certainly wouldn't classify them as volatile. So, I fully support keeping your EF in liquid assets such as stocks that should give you a greater return than a savings plan for your cash. But not necessarily in something volatile.

Volatility doesn't do well for an EF and does far better as a speculative play. Of course, everyone's definition of volatility is different. And if you are going with an index fund of some sort - stick with one with extremely low fees. Don't pay attention to the advertised rate of return on the funds - those are in advance of fees, pay attention to your real world return and you'll realize you don't even come close to the posted fund return.

[IPAfan]

Well I was trying to be somewhat general about the post and not talk about my specific investment(s). Usually I invest in individual stocks as well, and I've been doing it for several years with good success overall.

I've invested in volatile, leveraged companies in the past. I'm not intending to invest in an excessively volatile stock right now, but any individual stock (or index) can be volatile compared to cash. Just look at 2008 where the market was down 40%.

The particular investment I'm looking at right now is already a big holding of mine in my retirement accounts, but I want more. I believe the upside is substantial while the downside risk is very limited due to fundamentals rather than volatility. Two thirds of the company's market cap is in cash, with some very attractive operating businesses. Until the large cash balance is deployed I feel that it puts a major floor under the price. 2008 is a lesson that good companies CAN trade below net cash, but it's pretty rare.

[IPAfan]

Havoc,

Good point. I've had this go against me before as well, although overall the gains have outweighed the losses. What does TSTF mean?

[midjd]

"things started to fall"... I'm guessing?

[Deleted]

I have part of my EF is non cash. I am ok with it, as long as I can fund my EF back up quickly and I have a plan for what happens if I cannot stockpile enough cash before an emergency.

[Havoc]

Jun 13, 2011 9:31:01 GMT -5 IPAfan said:

Havoc,

Good point. I've had this go against me before as well, although overall the gains have outweighed the losses. What does TSTF mean?

I think I missed a letter, but it was supposed to reference when "The S#@! Hits the fan"..

And yes, having the $$$ invested has worked well for us... but then there have been a few times when we have gotten hammered, with all of the emotional angst of dealing with the emergency *plus* getting my nose out of joint because I had to pull $$$ out of the market and, in two instances, take losses. Now with a few months in cash, I don't sweat the little bumps in life knowing that I could cash in the invested part of EF, but don't have to right away.

[Havoc]

Jun 13, 2011 11:08:00 GMT -5 @patstab said:

We have a lot of our money in CD's, earning nothing but safe so far. could get it tomorrow with penalities but not huge.

Yep... we went all cash EF after the last time we had to realize losses in the market to cover hospital bills from birth complications... but that eventually drove me nuts because we were earning less than inflation at the time, and while I didn't mind it for a modest amount - an EF is a kind of self-insurance plan, after all - having so much in cash equivalents was too much for me. So we developed the plan of a few months in inflation-eroded cash, and the rest in mutual fund, which has worked out much better. We can dip into the cash part of the EF, and usually just replenish that from cashflow, leave the mutual fund alone.

[thyme4change]

Does anyone else consider liquid (but volatile) long term assets as appropriate for an EF?

I do. I have a month or two in cash equivilants - but because of the unlikelihood of a complete family meltdown, I'm willing to take the risk that I will have to liquidate under duress. I've had an emergency fund for 15 years, and I've never had to take a huge chunk out in a down market. Even if we both lost our jobs on the exact same day, I would only need to liquidate a little bit at a time. (A paycheck's worth every other Friday.)

Granted, my income situation is different from most. If either of us stopped working, we probably wouldn't need to liquidate any funds to keep up our mandatory expenses.

[SVT]

www.bogleheads.org/wiki/Placing_Cash_Needs_in_a_Tax-Advantaged_Account

Take a look at that and see what you think.

[thyme4change]

SVT - wouldn't that only work if your taxable investment account had a larger balance than your emergency fund?

I guess technically, if I really needed it, I could pay the penalty and withdraw from my IRA. I mean, if I were dying of some disease and wanted to try a new, uncovered procedure, I'd rather live broke than die rich.

[IPAfan]

SVT - That's EXACTLY what I did while I was in law school. I didn't have enough money to keep an EF AND contribute to ROTH IRAs, so I just contributed to the ROTH IRAs. I even had to withdraw my first contribution for an emergency. However, by the end of school I had over $30,000 in ROTH accounts that I couldn't otherwise have afforded. Finally I've been able to develop a bit of a taxable EF, but still have a long way to go.

cheesecakelady,

I know that people say I should never keep 10% in one particular stock. I think conventional wisdom is often worthless. Warren Buffet once put 65% of his net worth in American Express and then a similar amount in GEICO. I'd rather have 50% in one stock if it has great appreciation potential and limited downside risk than diworsify my investments. I think a lot depends on what stage you're at in life. For instance I'd never put a huge % in one stock later in life, but I'm at the early end of my career. I try to buy long term investments and it's quite frequent that I'll see one or two buying opportunities per year. Over time my portfolio will develop more diversity, but at this stage I refuse to buy into my 4th and 5th best investment ideas.

Why do I need to use an EF to pay for them? Because my investment accounts are fully invested, and at this point I don't want to sell any of the investments I'm holding since they're all long term investments (if I hold onto my LT investments then in 5-10 years I'll have a diversified portfolio). The question is whether I really NEED to keep this money in cash. We have available un-drawn credit, and have lived our entire lives without a fully funded EF (and now have a higher income potential). Also, a lot of my investment returns were put into law school living expenses instead of compounding.

[bobosensei]

DH and I recently decided to put part of our EF in the taxable vanguard index fund. So far it is working great for us.

[formerexpat]

I've seen Phil talk about keeping money invested in an index fund as an EF. Does anyone else consider liquid (but volatile) long term assets as appropriate for an EF?

I do exactly this.

I generally don't go as risky as it sounds you might go; like an individual stock or single position but I have over 6 figures in these LT index funds that is my EF.

My cash balances are minimal; essentially any large expenses I know I'll have in the next few months - like a deck and basement that we just completed...although, to be fair, I just used a 18 month 0% card to invest strategically in a single position - so I guess I kind of do what you do...but I can take money from another pot when the 0% rate is up if this position isn't favorable and I still want to hold.

Not sure your specific situation as far as cash flow is concerned though. You run the risk of eventually getting to the point where you're engaged on all of your positions, don't want to get out and don't have the means of getting cash if in need. You can best assess that risk. For me, I'm stable in my career and in a field that is very consistent, so my cash inflow is very reliable and we live on less than 50% of it and therefore cover very large cash needs in a short period of time.

[blackcard]

<<The problem with this type of financial engineering is that there's always the risk that the investment goes against me just when I need the money.>>

<<This HAS happened to me in the past, and it sucks.>>

Are you not the same poster, * who was so financially savy * that you were lecturing me on not keeping cash on hand, and you had such a better plan for my cash, a few weeks ago?

So this was that great financial plan? No thanks. I will pass on your plan. Again.

[IPAfan]

blackcard,

"Are you not the same poster, * who was so financially savy * that you were lecturing me on not keeping cash on hand, and you had such a better plan for my cash, a few weeks ago?"

Hmm. I don't think so. I really don't care what you do with your cash unless you want to give it to me Maybe I'm demonstrating a short memory? I'm certainly not perfect, and I'm always looking for advice. I think it's safe to say I'm probably better off than most of my peers, but that's about it. Pretty sure I've never described myself as financially "savy"...for one thing I would have spelled it properly.

To give you an idea about how these positions have gone against me...I invest in individual securities. I've had a LOT OF LOSSES and things don't go right 100% of the time for anyone. I've still earned just under 20% annually on my investments over the last 10 years including the losses.

Also, I looked through my recent posts and your recent posts. Pretty sure you've got me mixed up with someone else.

ExPat -

I've still got a somewhat diversified portfolio, and a lot of my investments are in holding companies which have a lot of built in diversification.

You've got a good point about being so tied to individual positions that I might not be able to raise cash without being able to sell some of those positions. I've had this come up in the past and just had to make do (and lost out on profits as a result). If I had an emergency I'd most likely use 0% CCs and would liquidate investments as a last resort.

Cash flow is good, and more than we need to live on. However, it's not nearly as regular as yours. I'm self employed as an attorney, but am in a fairly steady cash flow business.

[sunuva]

Volatility means something different to different people. I know that the "market" dropped in 2008 but not everything dropped like a rock. Anyway, that aside.

Every single one of my investments carries a Stop Loss Order (or Stop Limit Order or whatever it is your brokerage calls it). Worse-case scenario is you sell when you didn't want to. If the stock is widely held and actively traded there won't be any trouble executing the trade to lock in your position (in cash). As the stock price climbs upward, the Stop Loss Order is modified upward. It costs me nothing to place an order - it only costs me when the order is filled.

Now cash is not volatile. It is also not rewarding. If all that is being considered is protection of your principal there are lots of avenues for that.

[blackcard]

Sorry beerfan, it was not you. My bad. I will have to look it up.
Someone posting here a while back, was so convinced that me having a little EF cash on hand, about a miniscule $5K was so terrible, and they had such a great plan with what to do with it.
EF cash on hand I guess could be kept in a brokerage account, but I would want to make sure it was immediately avaiable, and that all of it was in tact, without a loss.
Is being 100% invested all the time a good thing? When it went against you, have you had other times that it worked for you? Did you come out ahead overall?

Sorry again, I know now I had you mixed up with someone else.

[IPAfan]

No problem blackcard, and sorry about the snarky comment.

I fully understand having an EF in cash. I try to do that MOST of the time myself, although I have invested my EF in the market when I think I've got a good opportunity.

I've had it work for me and against me, but overall I've made very nice profits on my stock market investments. I've been fairly conservative about using those profits to help pay for living expenses during law school and to stay out of debt. I graduated law school debt free largely due to good investment performance. Overall we've made almost 20% annually on our investments for the past 10 years (but a lot of that returns was from an investment I made in gold coins at $250/ounce in 1999, so it hasn't all been stock market gains).

I lost 22% in 2008 (which was better than the market, but completely unacceptable) and I'm lucky that was all. I took some huge losses on financials, but fortunately I bought PUT options on Freddie Mac that helped keep me from getting totally slaughtered.

My investments now are much more conservative since my biggest investment has about 65% of its market cap in cash net of debt. My big losses have always been from 1) overleveraged companies and 2) fraud (I lost a lot on a micro cap fraud and some chinese frauds.) I think I've improved my controls enough to avoid big losses on fraud. I'm avoiding Chinese companies, and my current overweight investment has a fairly long track record of buying distressed companies, turning them around, and spinning them off. So I'm at least more comfortable that I'm not being taken in by a fraud, although I suppose it's always a possibility. (That's why when I get closer to retirement I plan to limit my position size to a much lower % than I do now at 27).

[blackcard]

I just turned 31 last week. We are not too far apart in age. DH and I are squeezing all our extra cash into pre-payment of mortgage. Then we will look at more agressive investing.

Graduated law school debt free? Wow! I paid my way through college also. Did not borrow a dime. Worked and paid as I went. Took me 5 years instead of 4.

Guess I am just too conservative to put any our EF at risk just yet. Doubt if DH would even agree to it. We have not needed to use our EF yet, but you never know.

[IPAfan]

That's great that you've only got $58k to go on your mortgage at 31! Even if I put all my net worth into a house and then paid it off as fast as I could I suspect I'd be in my late thirties before I could pay it off. Personally I'm more comfortable with investing in stocks than real estate since I have some idea what I'm doing (where with real estate I've got no idea).