Is there any point in adding more than 6 months' runway in savings instead of investing everything after that?

Question

I have saved enough to be able to survive for 6 months. I don't have any debt.

So far, I've been investing a small part of my income in a diversified portfolio and have seen ~11% returns, which I'm very happy with.

If I make any further money which I don't spend, is there any reason to put it in my savings account or might I just as well invest it all? Interest rates are very low so I'm inclined to do the latter. I don't see why I'd need more than 6 months worth of savings.

“I don't see why I'd need more than 6 months worth of savings.” Being unable to work for seven months or longer immediately springs to mind, although that may well be unlikely. — Paul D. Waite, Nov 08 '19 at 10:11
I’ve known some very capable, which had been unemployed for 9months (of their choice) so that they could accept the job they wanted and not only accept something they were offered in the short run. Also, imagine looking for a job for 5 months and then needing to go to the hospital or your car breaking down or your friend getting married. Unexpected costs add up fast. — vol7ron, Nov 10 '19 at 13:55

score 41 · Accepted Answer · answered Nov 07 '19 at 11:14

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The six months of savings is for an emergency fund. The advice is for 3 to 6 months. This emergency fund is to cover you for a six month period of time if you are not employed. This isn't invested in any instruments that have the risk of losing money.

So what other purposes should you have a pot of money, in addition to the job loss emergency fund, that you are not investing in the stock market?

A life happens fund. This pays for a new refrigerator or an unplanned car repair.
Savings for a big purchase in the next few years. This could be a new car, or a new roof, or a new kitchen.
Vacation fund.
Money for a new place to live. Down payments and moving expenses take planning and saving.
A college fund. In some places parents save money to pay for their kids college. If the start is many years away it can be invested, but if the start is in the next few years safety is more important.

Some people can put all these funds in one pot, and know how they are meeting their different goals and timelines. Others keep them is separate accounts, or even different banks.

answered Nov 07 '19 at 11:14

mhoran_psprep

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Also, if you have a specialized skill set or other reason why a job search could take more than 6 months, you need a larger emergency fund to cover that. – pboss3010 Nov 07 '19 at 12:13
"A life happens fund. This pays for a new refrigerator or an unplanned car repair." Isn't that what the emergency fund is for? – Andy Nov 07 '19 at 23:49
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@Andy The emergency fund is to handle loss of income, this handles the unexpected bills. It can also cover a plane trip because of a family emergency, an unexpected medical bill, or accident deductible. – mhoran_psprep Nov 07 '19 at 23:57
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Why would any of those "funds" need to be in cash, rather than invested? Of the listed funds, only the life-happens fund is immediate and couldn't be covered by simply selling off some investment. In which case, you use the emergency fund, then sell off some of investment. The rest of the "funds" could still be in "investment" form while you're saving up, rather than cash! – Mars Nov 08 '19 at 01:38
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@Mars: That assumes that it will still be possible to cash in on the investments despite the catastrophe, and that said investments will still have value despite said catastrophe. – Vikki Nov 08 '19 at 02:55
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@Mars there are definitely many products available that offers high liquidity, but there is literally nothing more liquid than money in an account, besides having cash on hand. If you fully understand the risks and have mechanisms in place to liquidate in a real emergency, then by all means go put the emergency fund somewhere. Of course, even cash in a bank may be much harder to access if you got put in a coma, so I highly doubt you can liquidate assets very well if you are in some of the more severe emergencies (kidnapped, coma, both arms cut off, etc.) – Nelson Nov 08 '19 at 03:00
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@Nelson A college fund could be 20 years in the works before it is needed. There's no reason for that to be cash--in fact, it would lost a lot of value in 20 years as cash. I'd say anything where you will know when you need it more than a month or so in advance is better invested. You could keep a separate investment account as your "fund," but I still need no reason for that fund to be cash – Mars Nov 08 '19 at 04:11
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@Mars a college fund is not remotely close to what an emergency fund is... why is college fund even mentioned? – Nelson Nov 08 '19 at 04:14
@Sean Yeah, I'm making the relatively safe assumption that the following will not all happen at once 1) You need your life happens fund, 2) you lose your job, 3) some catastrophic event occurs that drops the value of ALL of your investments by more than the rate that you gained in between now and the time that these three events occur. Oh, and 4) That there was no advanced warning that these things would happen, so you couldn't take other precautions – Mars Nov 08 '19 at 04:14
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@Nelson Because this answer says you should have a pot of money not invested in the stock market, with college as one of the possible uses? – Mars Nov 08 '19 at 04:15
On second thought, the cash in each fund is losing value at the rate of inflation, but the investments have the potential to lost at a higher rate. The longer you intend to save, the more it's expected that you have a net-gain on your investment, so I still think the longer term funds are much better as an investment. For shorter term, I guess it depends on how confident you are that your investment won't tank during your investment period – Mars Nov 08 '19 at 04:29
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What is also nice to have is a "I-dun-effed-up" fund. A pot of money, if you now and then screw up, so you can throw money at the problem. I once booked a flight ticket the wrong date, and only found out when I was at the airport, that my flight left yesterday. It is easy to get angry at yourself or feel ashamed, but all that goes away if you have money set aside for when you have been stupid. So I threw money at it and away the problem went. Or rather, it stayed at the airport - I flew away. – Stian Nov 08 '19 at 08:17
@Mars The college fund need in 18 years doesn't need to be in cash, in fact the answer says that, but if the child is in high school and college starts in the next year or two then investing the funds is a big risk. Image all those kids in college during 2000-2002, 2008-2010, if their college fund dropped 25% just as it was needed. In the US there are college savings programs that automatically change the risk factor as the child approaches college age. – mhoran_psprep Nov 08 '19 at 11:14
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@Andy no, because most people who think of emergency funds like that, also think of every life issue as a problem that can be solved by throwing money at it. Mechanic says "changed the leaky radiator, you know your CV joints are starting to go (tikka tikka a little bit on sharp left turns meaning it's good for 3 years at least), might as well do both" boom emergency fund. Cut a finger open, boom $1200 ambulance, even though it's not life threatening and an Uber would do. Drop phone in water, boom new iPhone. For most personalities, emergency funds lust to be spent. – Harper - Reinstate Monica Nov 08 '19 at 16:55
@mhoran_psprep True enough and honestly, I missed that part the first time. But 2-3 years still maybe means throw it in CDs or something rather than stocks – Mars Nov 09 '19 at 12:31
@mars a CD is almost exactly the same thing as cash. Yes they have a time period which can complicate some things, but there is little risk to a CD. Putting 4 years tuition in the stockmarket when your kid is in high school is taking a big risk. – mhoran_psprep Nov 09 '19 at 12:34
@harper those personalities probably wouldn't be able to build a life happens fund either, so i fail to see your point. – Andy Nov 09 '19 at 19:14
@Andy It's why I don't endorse the idea of "emergency fund for casual emergencies". – Harper - Reinstate Monica Nov 09 '19 at 19:21
@mhoran_psprep I get that stocks would not be advisable for short-term savings. but the OP mentions funds in a savings account, so I don't know if its safe to assume that "pot of money" = CDs – Mars Nov 10 '19 at 10:29
@mars the economy cratering could easily cause 2, 3, and 4 to happen all at once. Some number of people laid off because of a recession are likely to have unexpected costs pop up at the same time. So I'm not sure how safe that assumption really is. – Kat Nov 10 '19 at 17:46
@Kat I'd suggest that 3 is a warning for 2, therefore 4 isn't happening. Also, you needing a new refrigerator (1) is unrelated to 2,3,4, and my claim was about all 4 happening at once. Plus, I was also considering "safe" investments, such as CDs – Mars Nov 11 '19 at 00:26

score 12 · Answer 2 · answered Nov 07 '19 at 18:34

TL;DR

I'd agree with most others: 3-6 months in cash, invest the rest. If you feel like 6 months cash is not enough, you can keep more cash, but if you have investments that you can sell without harsh penalties, it's probably safe to count them as part of your emergency fund for longer term emergencies such as extended unemployment.

Long version

One point I haven't seen people cover is that cash is, on balance, bad. We only want to keep as much as we reasonably expect to need with short notice.

Why? Because even if you have the same number in your bank account year after year, the purchasing power of that money decreases over time due to inflation.

General wisdom puts the rate of inflation at 3% per year, which essentially means that you lose 3% of your cash every year by just letting it sit there. That's not literally true, obviously (and not only because this year's inflation in the US is sitting at 1.7%), but on balance, a liter of milk, toe nail clippers, a basketball, etc, will cost 3% more this year than they did last year.

So in that sense, yes, you want to continually increase your emergency fund as your living expenses grow with inflation (or for other purposes). But every pound sitting in your bank account is a pound losing value. Thus, you should think hard about how much money you'll need on short notice and look into investing everything else.

Also consider that many savings vehicles are low commitment: you can pull your money out on relatively short notice. So just because it's "invested" doesn't mean it's completely inaccessible if you need it -- it'll just take a few weeks to get it and you might have to sell low if we're in an economic downturn or something. That means that, even if you ARE out of work for more than 6 months, you can easily sell off your investments to cover that.

I get the point about inflation, I really do. I was a believer. My personal dilemma right now is that there are no "safe" investments that guarantee to beat inflation. Everything is effectively a gamble - even if you "study the form" first. Even index tracking can "fail" you if your "exit point" is wrong. I mean a point such as you retire, or stop working / having ANY income, and it happens to be bottom of a massive depression. I was born in 1971 - I have seen a lot of change, crashes in various markets, wildly varying interest rates and levels of government interference in the economy! — kpollock, Nov 08 '19 at 10:01
Put another way, the way I rationalize my position is that all we have is faith that things will continue, more or less, to be as they have been in the past, tumultuous though current times may seem. If we try to prepare for the apocalypse, don't bother with money -- it will probably not have any value anyways. Buy an inland homestead, learn how to live off the land and stockpile weaponry to protect your assets. — bvoyelr, Nov 08 '19 at 13:53
@kpollock Massively typoed a previous comment. Here is the corrected version: Thought experiment: You invested in the S&P500 in 1989 -- 30 years ago. Over that time period, its returns were 1,100%. It was worth $285 then, now it's $3085. Cut its value in half to $1,500 to simulate a massive recession, and its returns are a mere 550%--5x the inflation rate and $900 over what your original $285 would have become had it simply kept up with inflation ($285 in 1979 is $600 today). Even considering recessions, you're better off investing in index funds than even keeping up with inflation. — bvoyelr, Nov 08 '19 at 13:59
I do believe there are points in time where the same calculation does make a possibeloss with index funds - but I will have to go look it up. I algree it is unlikely, but it is not impossible. " all we have is faith that things will continue, more or less, to be as they have been in the past," that is my point, I personally no longer have that faith, which makes me question. I am not a survivalist :-) Those skills are also not trivial to learn! — kpollock, Nov 11 '19 at 10:44

score 9 · Answer 3 · answered Nov 07 '19 at 13:57

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I don't see why I'd need more than 6 months' worth of savings.

If you work in a region dominated by one company or industry and can't/won't move, then having more than six months of expenses socked away in something stable would be a good idea. Especially if that company nosedives right around when the market falls like a stone.

answered Nov 07 '19 at 13:57

RonJohn

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Sure. Let's make it 12 months then. But after I hit the 12 months mark, should I keep saving even more? – ignoring_gravity Nov 07 '19 at 17:42
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@ignoring_gravity Yes, you should keep saving even more, but to stocks, rather than stable instruments with poor return (bonds). – juhist Nov 07 '19 at 17:46
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@ignoring_gravity TBH, your question is very similar to another I answered yesterday. https://money.stackexchange.com/a/116557/22266 – RonJohn Nov 07 '19 at 18:04

score 4 · Answer 4 · answered Nov 07 '19 at 21:29

If no one is depending on you - six months should be plenty.

(depending = spouse, child, parent, etc.)

Put the extra into investments.
The money you invest is still available to you if you need it.

The downside is that if there is a bad economic problem and you lose your job at the same time then you may need to pull the money out while the investments were worth less than you paid for them... but remember you've got a six month runway to use up before you're forced into that.

You'd likely be able to cut your expenses further if you're unemployed... stretching your six months of money out longer than six months.

A person who is highly skilled in a job but has no transferable skills, say factory worker who operates a specific machine, may need 6-12 months.
That worker could be replaced by a new machine which doesn't need an operator.

A person who has transferable skills (a welder in that same factory) would only need 3-6 months.

Saving for a house / child's education / car / wedding should be done in addition to the six months expenses and you can do that either in savings or in an investment depending on the purpose and flexibility of when the expense occurs.

+1 for "The money you invest is still available to you".
The key question is one of liquidity. Your cash savings should be able to tide you over long enough to sell your investments, and ideally they should also give a bit of choice as to when, so that you're not a motivated seller who has to take a bad deal. But other than that, 6 months runway cash + investment + interest is probably greater than 6 months runway cash + would-be-investment. — Josiah, Nov 09 '19 at 18:31

score 2 · Answer 5 · answered Nov 07 '19 at 12:37

There are some very good reasons to have more than 6 months of income saved, and also some good ones to have less. You must weigh what applies to you.

For example a person with a very secure job, who has a spouse that also works and has expenses that are less than either salary probably does not need 6 months of savings. Three months could be more than sufficient as if one lost their job, they could live off the other's income.

Alternatively if those same people have aging cars, and home renovations forthcoming, they may save much more than 3 or 6 months savings so they can pay cash for the replacement cars and home improvements.

A person in your case may have more in savings for a variety of reasons: your company isn't doing well, you may be interested in buying a house, or you may need a replacement car are all examples.

So yes there are viable reasons to have both more and less in savings than 6 months of expenses. From what it sounds like you are doing really well. Are you utilizing a high yield savings account such as Ally? Many pay around 2% interest as of this writing.

mootmoot · Answer 6 · 2019-11-08T09:18:01.727

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If you treat saving as a buffer for flexibility, then you will see the opportunity cost from a different perspective.

In life, even if you have everything cover by social security net and insurance, it is still a bad idea by putting yourself into a stringent financial position. Sometime life events or opportunities will appear in unexpected timing e.g.

An unexpected event that required you spend a few months of saving
Some stocks that you are eyeing dip to your desired price level

Without the buffer, you may end up resort to an expensive loan(e.g. credit card) or pass on those attractive investment opportunities.

To offset interest loses on the cash, you can always resort to financial like fixed deposit. Though the 0.5% ~ 1.5% APR fixed deposit is nothing to brawl about.

edited Nov 08 '19 at 09:18

answered Nov 07 '19 at 13:10

mootmoot

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Yes, but should my buffer be ever-increasing, or at some point should I decide it's large enough? – ignoring_gravity Nov 07 '19 at 17:42
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@ignoring_gravity At some point the marginal benefit of an additional saved dollar will be less than the marginal benefit of an additional spent dollar. But you'd have to do some math on how likely you are to want to dip into your savings, and how important the thing you would spend them on would be, versus how much you value whatever you would spend it on now. – interfect Nov 07 '19 at 18:30

score 0 · Answer 7 · answered Nov 08 '19 at 16:55

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This depends on you, and how much cash you like to have. Personally, I love cash, I love having way more of it than I need. Every additional dollar that I have that I don't need makes me feel more comfortable with any situation life throws at me because, I have cash, and you need cash to survive.

So, do you feel comfortable with 6 months? Is that more than enough for you to walk around not feeling on edge? If so, then yeah put the money somewhere else. If not, keep contributing. I contribute to savings every month regardless, it's just a good habit and it makes me feel secure. I then perform better at work, am more inclined to take a risky job or invest in a riskier opportunity.

Also keep in mind that with inflation within the next year that 6 months savings won't be 6 months anymore, so you actually need to keep saving to keep up with it.

answered Nov 08 '19 at 16:55

logos_164

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"with inflation within the next year that 6 months savings won't be 6 months anymore, so you actually need to keep saving to keep up with it." Or save in a vehicle that keeps up with inflation. (That's country specific, though.) – RonJohn Nov 08 '19 at 16:59
@RonJohn true but I left that out because in a savings account I just keep cash I don’t put it into any vehicles – logos_164 Nov 08 '19 at 17:00
Savings accounts are vehicles, and there are many savings accounts that pay more than 0.01% interest. – RonJohn Nov 08 '19 at 17:11

score 0 · Answer 8 · answered Nov 08 '19 at 18:32

Where's your retirement?

Let's review how compounding works. When you invest, you get interest/dividends/gains. Normally, those gains are themselves reinvested. Suppose your investment makes 10% a year. You start with $1000 and get $100 back in the first year, and reinvest. What happens after 30 years?

$100 back x 30 years = $3000, right?

No sirree. Because the interest is also invested, and that compounds:

Year 1 you get $100 growth giving $1100. (as expected)
Year 2 you get $110 growth giving $1210. ($110 not $100. Small? Fasten your seat belt.)
Year 3 you get $121 growth giving $1331.
Year 4 you get $133 growth giving $1464.
Year 5 you get $146 growth giving $1611.
Year 6 you get $161 growth giving $1772.
Year 7 you get $177 growth giving $1949. (you expected this in 10 years.)
And I won't bore you but at 10% it doubles every 7 years-ish.
Year 14 you have $3797.
Year 22 you have $8140.
Year 29 you have $15,863.
Year 36 you have $30,913. Yes. From your original $1000 with no additional contributions.
Year 43 you have $60,240. Wowza!

Back to retirement.

You're not thinking at all about retirement. Why not? Because it seems much too soon to think about retirement!

Now imagine you save $1000 for retirement every year for 10 years, and stop. (You don't need to stop, but say you did). You take it out 45 years after you start.

Year 1's $1000 has turned into $72,890.
Year 2's $1000 has turned into $66,264.
Year 3's $1000 has turned into $60,240. Wait. Why are these numbers dropping so badly? That is the power of compounding interest not working for you.
Year 4's $1000 has turned into $54,764.
Year 5's $1000 has turned into $49,785.
Year 6's $1000 has turned into $45,259.
Year 7's $1000 has turned into $41,145.
Year 8's $1000 has turned into $37,404.
Year 9's $1000 has turned into $34,004.
Year 10's $1000 has turned into $30,913. Wow, 30 grand is awesome, but that earlier money made $72,000, so it feels like weak tea, eh? Total: $492,669 in retirement.

Boy, you sure wish you could've contributed the entire $10,000 in the first year and had $728,900, eh? That's $235,000 more, which makes that year of surviving on flip phones and ramen seem actually pretty reasonable.

Now let's take Doofus McGee. Doofus did the same exact thing, but started 15 years later, with only 30 years to go. The first year multiplied to $17,449 - uh-oh. The whole 10 years totals up to $117,941. Talk about surviving on ramen! Doofus will have to do that for a lot longer than a year! Sorry Doofus, you started too damn late.

Don't be a Doofus

It's not even a case of screwing up. It's a case of not having it, and never knowing it was there in the first place.

I'm not even saying deposit $1000 into retirements savings. I'm saying deposit the max you can possibly bear to invest. Your first preference is Roth* 401K, then Roth IRA, then Trad. 401K. Don't even bother with a Trad. IRA.

401k > IRA because it is better protected from life's little misadventures such as bankruptcy. 401K/403B are protected Federally; IRA protection varies by state. (NEVER use a 401K or protected IRA to pay off debt; lump the bankruptcy and emerge with the 401K intact.) Roth > Trad for a bunch of non-math reasons, not least total freedom to withdraw at any rate you please without consequences, making it a warm, lovely, growth-is-tax-free place to keep your money until you need it.

Wait. How do I invest this?

Yeah, investing is a mad nightmare. But it is made so by humans, with the express purpose of confusing casual investors so they will just stop thinking and trust their broker. Actually, when you play the investment game hardcore, it gets very simple.

Consider a university endowment. It is a staggering pile of money on the 9-10 digit range. It must last forever. The earnings fund various university programs, like professorships, fields of study, etc. It is invested by the smartest bankers in the world. The investment strategy is carefully scrutinized by a Board of Directors, and half of them are themselves investment bankers, and this squabbling bunch must agree to consensus on the best investing strategy. Almost all of them do this, +/- 10%:

70% domestic stocks, many/most/all of them, in low-expense-ratio mutual funds
15% foreign stocks, ditto
15% bonds, particularly safer Muni bonds
5-10% each in a few other things, varying

Why? Because they don't give a damn about short term gains or losses (volatility). They want maximum growth, and volatility is irrelevant because they're playing a long game. In fact, keeping those ratios means they are buying stocks like mad when they're in the toilet, and selling off stocks when they are high, to keep the value ratio 70/15/15 or whatever policy the Board has concurred on.

Any retirement fund with a >20 year horizon has the exact same objective as an endowment. And you can buy these classes of investment in any 401K or IRA.

That was easy!

Returns only matter in the short term

Did you catch the part about how the endowment managers don't give a damn about volatility? That refers to the 11% returns that you're proud on. That's a higher than average gain, which means, that gain can turn ice cold on you. This is the part where many novice investors curse themselves and become very demoralized and distrustful of investing. And endowment managers keep right on not giving a damn. To them, this is just the market being the market. They're in it for what the market does long-term, which is grow steadily at about 6-9% above inflation.

So take their viewpoint when/if that investment gives you a bloody nose. It's just the market being the market. If the market drops 50%, don't set your hair on fire, go "Wall Street is having a 50% off sale!" and buy even more of what you just got shellacked on. Because it will come back up. It always does. All those people in 2008 who simply stayed in their investments recovered fully in a couple years, and are now fat and happy.

That said, if you do "short" term invest, try to hold on to the investment > 1 year, so it counts as a long-term capital gain and earns a much lower tax rate. And diversify: the best book on that is John Bogle's Common Sense On Mutual Funds. Bogle will also tell you how to minimize the guaranteed losses from excessive management fees.

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* And I know I'm going to get arguments from a bunch of theorycrafters. The theory is, if you withdraw from the Trad at a perfectly uniform rate from retirement to death, and tax rates remain about as they are, it means the money may be taxed in a slightly better tax bracket. But that requires having no medical crises and knowing when you're going to die. Life does not work that way. They have never had to massively spend down an IRA in a medical crisis and you're suddenly in a 39% combined tax bracket because it's taxed as income on the way out... so much for your lower tax bracket in retirement!!!