How many times have you heard that you need an emergency fund? Probably a lot.
But do you really need to pay the cost of having a lot of cash lying around? I don’t think so.
The truth is, having an emergency fund is completely optional if you have good money habits and are diligently investing to build your financial freedom.
Cash sitting around will not make you any richer! Not only will inflation eat away at the value of your cash, but you will also miss out on investment gains which especially hurts during years of significant market outperformance.
If you learn to track your expenses, manage your cash flows, and properly insure yourself against unaffordable expenses, then you can avoid having to pay the cost of keeping an emergency fund.
Over the long run, you will be richer from it.
Build Good Money Habits Early: Track Expenses And Manage Cash Flow
Building good money habits early on is an 80/20 way to becoming financially successful.
One of the most important skills to master in personal finance is keeping track of your expenses, especially large fixed recurring expenses, and managing your personal cash flows from your day job, passive income streams, investments, and other sources.
The difference between all your monthly cash flows and expenses is the amount of money that you can put toward investments or save for upcoming one-time expenses that can’t be covered by your monthly cash flow.
If you can learn to stay on top of your expenses and manage your cash flows, you will never need to pay the opportunity cost of having an emergency fund.
For me, the easiest and most efficient way to handle expenses and cash flows is through a money system.
My system allows me to hit a 50% target saving rate, pay off all recurring monthly expenses and interest-free credit card bills, and then decide to spend or invest the leftover cash flow from the month. This allows me to focus my time and energy on other important things.
Being Cash Poor Can Make You Rich
Strive to be “cash poor” and “cash flow rich.” That way all your cash is being used optimally towards living your life, investments, and building more income streams!
Outside of keeping a month’s worth of cash for any unexpected fluctuations in monthly expenses, I prefer to have zero cash sitting around waiting for an “emergency” to happen.
For any big expected one-time expenses (e.g. moving, wedding, vacation, etc.) that are coming up in the foreseeable future, I can plan out my cash flows and redirect funds to save for these expenses.
If any big unexpected one-time expenses (aka an “emergency”) come up, I can use a combination of credit (e.g. credit cards, HELOC if you own a home, etc.) to cover it and then pay it off with cash flows before the payment and any interest is due. Note, if you are properly insured against unaffordable risks (more below), then the chances of having massive unexpected expenses are extremely rare.
Even in the absolute worst-case scenario, if you don’t have enough cash flow to cover your expenses, you still have options. Because you own a substantial amount of assets, you can sell some of the liquid ones (e.g. stocks, bonds, etc.) to cover any unexpected events.
For me, this system has worked very well over the years. The money that I chose to invest instead of keeping in a giant emergency fund has already grown so much that the gains alone cover all the recent “emergencies” I can think of.
So my advice to you, if you have built up good money habits, is to have just enough cash lying around to make you feel comfortable and that you will be willing to pay for in lost opportunity cost.
Three to six months of living expenses in cash is likely enough liquidity for most people, while less than three months (or maybe even one month!) is great for those who have built good money habits and a strong financial foundation.
If you do decide to choose to keep a substantial amount of cash for large-expected purchases like buying a house, having a wedding, capital calls, or some personal reason, make sure to keep earning some interest in a high-yield savings account, money market fund, CDs, or short term Treasury to reduce the lost opportunity cost.
Don’t be fooled into mental accounting. Money is money no matter what type of account it’s in (i.e. it’s fungible). The cash in your checking account or an emergency fund could very well be sitting in your investment account or interest-bearing loan, earning you money while you wait to use it.
Fear Of Not Having Enough Cash Is Overblown
Just like the fear of running out of money in retirement is overblown, the fear of not having enough cash (i.e. liquidity) is overblown when you have built good money habits and are properly insured against unaffordable risks.
The biggest risk to your financial life is catastrophic black swan events that can cause you to liquidate your assets or worse, bankrupt you.
Medical Debt – Protect Yourself With Health Insurance and Disability Insurance
Medical debt is unfortunately the #1 reason for bankruptcy in the country accounting for more than ~62% of all bankruptcies in a study done by Harvard Medical School.
To protect yourself, make sure you have an appropriate health care insurance plan at all times. Understand your benefits and have a deductible and out-of-pocket maximum that you can afford.
Having health insurance will limit the maximum cost of any medical issues in any given year to an out-of-pocket maximum that you can afford in the worst-case scenario.
If you are early on in your career and not yet financially independent, then you should also have your own individual long-term disability insurance in the event that an injury prevents you from doing your job.
Most employers will provide short-term disability insurance for 3-9 months as part of your employee benefits, which will pay out benefits during the elimination period of your long-term disability insurance until the policy kicks in.
However, if those issues cause you to be permanently disabled and unable to work again, that will be a financial catastrophe you cannot afford.
Every high-income professional should have their own individual long-term disability insurance until they are financially independent and don’t need to actively work in order to support their lifestyle.
Job Loss – Protect Yourself With WARN Act, Unemployment Benefits, and Severance
Job loss is another reason that can cause people to hoard cash for fear they will run out of money.
Unless you are fired for cause or quit your job, getting laid off will guarantee that you have certain protections and get you paid to leave your job.
If you are in the growth phase of your career and building wealth, you should already be controlling your expenses and practicing sustainable lifestyle inflation, so you don’t have to be concerned about job loss.
If you get affected by a mass layoff, then you will have 2-3 months of federal and state-mandated WARN Act pay, providing you with 2-3 months of extra paychecks or ~4-6 month runway of living expenses assuming you have at least a 50% saving rate.
On top of that, you will be immediately eligible for unemployment benefits, which can bring in around ~$2K of cash flow a month (for New York state), providing you an additional ~$13K of cash flow for up to 6.5 months.
Lastly, you can negotiate a severance package that will pay you a lump sum amount based on your position and years of service (typically guideline is 2-3 weeks of pay per year of service) along with a slew of additional benefits such as continued healthcare insurance coverage under COBRA, vesting of any existing deferred compensation, leftover PTO days paid out, etc. to provide you with a bigger runway until you find another job.
Henry’s Massive Financial Runway In A Layoff
As an example, to show how you can be protected in the event of a layoff, let’s assume Henry has worked at his NYC-based company for 5 years, makes $300,000 a year, and spends $6K a month.
His company notifies him that he is being terminated in 3 months, complying with the WARN act, and he continues to get paid ~$75K during that time (~$45K after taxes) so he has time to find another job. He immediately applies for unemployment benefits which brings in an additional ~$2K a month for up to 6.5 months (~$8.5K after taxes) since he is no longer employed as soon as his employer notified him about the layoff.
In addition, he negotiates a severance package worth 2 weeks for every year of service or an additional ~$38K of income after taxes along with continued healthcare insurance coverage paid by his employer, vesting of his deferred compensation on its original schedule, and all his leftover PTO days paid out.
In total, Henry is being paid ~$91.5K of after-tax income to be laid off along with any existing PTO days and deferred compensation paid out after his employment is terminated.
This gives him a 15+ month financial runway to fully cover all his pre-layoff monthly living expenses without needing to tap into any of his savings and investments.
Since Henry is also a rational person, he knows that he can also cut down his discretionary expenses or geoarbitrage to a cheaper area temporarily to extend his runway even longer if he really needs to, further extending his runway.
In the worst-case scenario, if Henry is unable to find another job for ~2 years (extremely unlikely when he has just freed up 60-80+ hours of time to hunt for a new job), he can use the 4% rule and use his investment portfolio to sustain his minimum living expenses.
Knowing this, Henry is in an extremely comfortable financial position despite any economic uncertainty or risks of job loss and can continue aggressively earning, saving, and building his financial freedom so he can live his ideal early retirement lifestyle.
Accidents and Lawsuits – Protect Yourself With Liability Insurance and Umbrella Policy
Another major cause of huge expenses is unexpected accidents that can happen to anyone in day-to-day life.
In addition to having healthcare insurance coverage and disability insurance if you’re not financially independent, you also want to be protected at all times against accidents and lawsuits where you might be liable for huge settlements you cannot afford.
Having proper car insurance (or non-owner car insurance if you rent or borrow), homeowner insurance, renter’s insurance, and an umbrella policy will protect you from unpredictable accidents that can happen to anyone.
Divorce – Protect Yourself With A Prenup Or Consider Staying Legally Single For Tax Savings
In every marriage, divorce is an expensive and messy risk that has a non-zero chance of happening.
If you plan on getting married, consider getting a prenup that is drafted by lawyers on both sides to protect you and your spouse in the event of a divorce.
Alternatively, if you and your spouse don’t want to bother with a prenup and want huge tax savings, consider staying legally single for tax purposes!
In this day and age, high-income married couples unfortunately have to bear the burden of the marriage tax penalty which can cause them tens of thousands in additional taxes every year!
Staying legally single with your spouse could potentially save you millions of dollars in taxes and opportunity costs over the course of your marriage.
Everything Will Be Fine If You Are Financially Savvy
At the end of the day, if you are financially savvy there will never be a reason to worry about unexpected financial “emergencies” that can happen.
Just like you will likely never run out of money in retirement, you will always find a solution to your financial problem and a way to adapt to your circumstances.
If you don’t have big living expenses and you’ve got a portfolio of decent diversified businesses. You really don’t need any cash.
Warren Buffet
If you are financially savvy and still have a large amount of cash sitting around, you ask yourself why.
If you’re paying for the cost of having cash, make sure you are doing it intentionally and for personal reasons, not because mainstream financial media told you so.
Make sure you are tracking your cash flows and expenses using your own money system, and are properly insured against large, unforeseen catastrophes.
Having no emergency fund has worked out well for me and has put more money in my pocket over the years.
Maybe it can make you richer too.