Conventional personal finance wisdom says that it’s essential to have a designated emergency fund. The typical suggestion is that your emergency fund should be a checking, savings, or money market account with 3-12 months of living expenses in it.
But is there a point at which there’s no need to keep a separate emergency fund? That is, is there a point at which your retirement portfolio (and other assets) can do double duty as your emergency fund?
I think there is. If your retirement portfolio is large enough, liquid enough, and accessible without adverse tax consequences, you don’t necessarily need a separate emergency fund.
Is Your Portfolio Large Enough?
In order to be able to safely do away with your emergency fund, you have to know that, in the event of an emergency, your portfolio would be large enough to satisfy any immediate, short-term spending needs.
Whether or not it can do that depends on the size of your portfolio, your asset allocation, and the size of any potential unplanned spending needs.
For example, if your stock holdings declined by 50% over the next year, and at the end of that year you got laid off or found out you needed a major home repair, how problematic would it be? The more problematic such a scenario would be, the greater your need for an emergency fund.
Are Your Assets Liquid Enough?
In order to live safely without an emergency fund, you also have to know that you can turn your assets into spendable cash in a short period of time.
For example, if you place a sell order for one of the holdings in your brokerage account, you should be able to have the money in your bank account within just a few business days. For most unexpected spending needs, that should be just fine.
In contrast, if most of your net worth is tied up in something significantly less liquid (real estate or a lifetime annuity, for example), you probably need an emergency fund.
Finally, in order for it to make sense to do away with your emergency fund, you need to be able to get to your money without adverse tax consequences. If you’re under age 59½, you would want to make sure you have sufficient Roth IRA contributions (which can be withdrawn free from tax or penalty at any time) or sufficient holdings in taxable accounts (without large unrealized capital gains) to satisfy any unexpected spending needs.
As with most personal finance concepts, the above discussion comes with some exceptions. Most importantly, if you know you’re not going to be able to sleep at night without a certain-size pile of cash in your checking account, the question of whether or not you need an emergency fund pretty much settles itself.