I’ve never been a fan of the idea of keeping a lot of cash set aside.
Be it for emergencies or anything else, sitting on a significant amount of cash is usually just a bad idea. Anyone who has learned about the power of compounding, the time value of money, and the potential for long-term investing in quality assets quickly realizes this. Cash is nothing more than pieces of paper.
Many people think of cash as king.
No. Cash is trash.
Regularly putting my cash to work in high-quality investments helped me build the FIRE Fund. That’s my real-money early retirement stock portfolio. And it generates the five-figure passive dividend income I live off of.
I went from below broke at 27 years old to financially independent and retired at 33. Retiring early is something that I think almost anyone out there can do, as I lay out in The Dividend Mantra Way and 5 Steps To Retire In 5 Years.
If I would sat on a lot of cash all along, I wouldn’t be where I’m now at.
Now, I do think typical people should keep an “emergency fund”.
Keeping 4-6 months’ worth of expenses in liquid cash makes sense for most people. This cash is there as a nice backstop, just in case one were to lose their job or some kind of expensive problem were to suddenly befall them.
This advice is for typical people. And that advice comes from your mainstream financial advisors. Of course, typical people aren’t reading this blog. And I’m not a mainstream guy.
Typical people have jobs. They have homes, cars, and fairly expensive consumer-based lifestyles. They’re living from paycheck to paycheck. Financial independence is not exactly in their everyday vocabulary. Retiring at 30 or 40 years old is not even on their radar.
In that kind of scenario, I think an emergency fund is a good idea.
However, I don’t think an emergency fund is a good idea at all for people who are aiming to achieve financial independence and retire early.
Nor do I think it’s necessary.
If you’re going to achieve FIRE, you’re going to have hundreds of thousands (or potentially millions) of dollars in high-quality, income-producing assets. That’s a given.
Thus, your “emergency fund” is right in front of you. It’s that, umm, gigantic pile of money you’re sitting on.
Moreover, anyone who’s going to achieve FIRE is going to be very fluent with money. They will have greatly reduced their recurring expenses, making the idea (or, at least, size) of an emergency fund far less applicable. Simultaneously, an emergency fund, in this case, might end up simply being the cash they sit on as a buffer for normal day-to-day life.
The average American consumer unit spends more than $5,000 per month. Six months’ worth of expenses would be over $30,000, in that example. That’s a lot of money.
But someone aiming to achieve FIRE is probably spending a fraction of that. My monthly expenses, all-in, average somewhere between $1,400 and $1,500 per month these days. I mean, I can keep a few grand in walking-around money and have two months’ of expenses saved up completely by accident.
Plus, there’s the fact that these low expenses usually contrast against a much higher income. This is because it’s necessary to save a high percentage (50%+) of one’s net income in order to have the regular capital necessary to invest and achieve FIRE. If you’re saving and investing $3,000+ per month, you have a regular stream of substantial cash flow that you could quickly and easily divert toward a different cause.
In addition, it’s often a resourceful and enterprising person that is going after FIRE. They think outside the box. They’re scrappy. And they’re creative. Coming up with a grand or two in short notice should not be a problem.
Plus, there’s always the access to credit. Keeping a few quality credit cards around (with those valuable points) means you probably have mid-four-figure credit available to you, which could be tapped in an emergency.
With all of that working to your advantage, you’d be crazy to sit on cash instead of having it go to work and compound on your behalf.
I’m lazy enough. I don’t need my money to be lazy, too. I’d rather have it out there working hard for me.
Money works 24/7. Money never gets sick, tired, or cold. It’s a machine. And this machine is too powerful to have it collecting dust.
So those are my thoughts on the matter.
But what does Warren Buffett, arguably the greatest investor to ever live, think about this?
We don’t have to wonder. It just so happens that he was recently asked about this.
The question wasn’t laid out in a way that explicitly ties it to early retirement, but Buffett did weigh in on whether or not people who are independently wealthy and retired should keep aside a pile of cash for emergencies.
Talking to Andy Serwer, as part of Serwer’s Influencers series, Buffett was asked how much cash an ordinary investor should have set aside on a percentage basis.
Buffett’s initial response:
It depends on their personal situation. If you’re working in something where you’re living off your paycheck, from week to week, you want to have a little cash around. And you certainly don’t want to have a credit card maxed out.
This is speaking to the typical person here. As I noted above, an emergency fund is a good idea if you’re the average American who’s living from paycheck to paycheck.
Buffett continues, now speaking to someone who’s a level up from your average American:
But if your house is paid off, you don’t have big living expenses, and you’ve got a portfolio of decent, diversified businesses, you don’t really need any cash.
I’d agree with this. If you’re in a good financial position, and you’re not living from paycheck to paycheck, it’s doubtful that you’d find yourself in a position where coming up with $10,000 suddenly would be difficult, even absent a lot of liquidity.
So we’re moving up from one level to another. Buffett then adds to this, finally speaking to those who are financially independent and retired. This is where the Buffett starts to speak to us:
If I were retired – I had, say, a million-dollar portfolio of stocks that was paying me $30,000 a year in dividends or something of the sort, my children had been grown, and the house was paid off, I wouldn’t worry too much about having a lot of cash around.
There you go. That’s your answer on the idea of having an emergency fund within the framework of financial independence and early retirement.
What Buffett is saying here is pretty clear.
An emergency fund is not necessary, or even a particularly good idea, for those aiming to become financially independent and retire early.
Buffett is explicitly telling you that you do not need an emergency fund.
With that said, I do think Buffett’s final answer is targeted toward a person who’s retired in the more traditional sense. You know, in their 60s or 70s.
However, Buffett’s rationale is actually magnified for those who are retired early. That’s due to the time value of money. A million dollars at age 40 is worth a hell of a lot more than a million dollars at age 70. Truth be told, I’d much rather have $500,000 at 40 than $1 million at 70. It’s not even close.
In addition, someone who’s retired early, sitting on a life-changing pile of money that’s paying out a hefty amount of passive income, is almost surely in the kind of physical and mental condition that predisposes them to continue making an active income of some sort – an active income that can serve as its own form of an “emergency fund”.
In fact, I’ve argued before that the early retirement math is moot. Anyone driven and intelligent enough to achieve FIRE is going to be driven and intelligent enough to continue doing cool things and making money. They won’t be content to sit around and just collect money. One could even question how necessary full financial independence is in the first place.
I’ve been saying for years that an emergency fund is a foolish idea for anyone aiming to achieve FIRE. I would have held myself back had I allowed myself to put aside cash to collect dust. I’m very glad I didn’t do that.
But I thought it was very interesting to hear Buffett weigh in on this. And it was nice to hear the man himself agree with what I’ve been saying all along.
If you want to keep an emergency fund, even knowing that it’s to your detriment, because it helps you sleep at night, that’s okay. Some people buy expensive mattresses. Others have emergency funds. Whatever gets you through the night.
But I’m glad to know that Buffett and I are on the same page in this regard.
What do you think? Is an emergency fund necessary within the context of FIRE? Agree with Buffett?
Thanks for reading.
Image courtesy of: DonkeyHotey via Flickr.
P.S. If you’d like to achieve financial independence, which would negate the need for an emergency fund, check out some fantastic resources I personally used on my way to becoming financially free at 33!