Coronavirus and An Emergency Fund

If there was ever a good reason and time to have an emergency fund, this is it. The Coronavirus has put millions out of work or at reduced pay. This could go on for many months and have a much longer impact on the economy. Congress and the President have agreed on economic stimulus packages that include direct payments and increased unemployment benefits. It could take weeks, however, before the government can logistically distribute the funds. State unemployment web sites are crashing from the the volume of people applying for benefits. 

Pattee Library at Penn State in Spring

The unemployment rate was so low a month ago that most people who were looking for a job could easily find one in their field. Companies are laying off hundreds of thousands of workers per week. Finding a job is much more challenging, if not impossible for those who lost their positions. There may not be new jobs or jobs to return to for a long time. The best way to manage a lost job or reduced income is with an emergency fund. 

What's an Emergency Fund?

It's enough money you saved up and set aside to cover your regular expenses for 3 to 6 months or longer. The fund is dedicated to emergency use. It's not to be used for a vacation or when you get car fever car. The emergency fund is money readily available in a bank account or money market account. It's not money invested in retirement accounts or tied up in investments in a brokerage account. Why not? Because when you need the money in an emergency, it's likely to occur after the market plunged, like it recently has. 

Those investments you were counting on in your brokerage account may be worth 30% or 50% less than they were a month before. You'll be forced to sell the investments at a lower price to raise cash. There may also be tax consequences for selling investments or borrowing from a retirement account. 

How Much of an Emergency Fund Do I Need? 

In normal times, that depends on what you do for a living and how easy it would be for you to find another job. If you have a stable job working for government or in a field with very low unemployment, 3 to 6 months may be plenty. If you are in construction or a freelancer, you may need to build up 6 months to ride out the lean times. If you are in a niche field where it's difficult to find a position or have health issues, you might need up to 12 months of expenses saved up. During normal times, if there is such a thing, you may be able to pick up part-time work so that you at least have some money coming in until you find a long term position in your chosen field.

Now that we are in the midst of a pandemic, an emergency fund of 12 months may be needed for most people out of work as jobs are scarce. Sure, the government is working to get money flowing to those out of work, but how long will it take? Just a month into the pandemic in the United States, it's been reported that one-third of renters missed their April rent payment. 

After the government does get the money flowing, how long can they keep that up before the tap runs dry? When the economy does fire up again, many businesses and jobs may not return. It's best to be prepared for the long haul with an emergency fund. 

Benefits of an Emergency Fund

When you have a fully funded Emergency Fund, things that used to be emergencies become manageable events. Unexpected home or car repairs are nothing to worry about when you have plenty of money to cover them. A job loss can be terrifying if you don't have enough saved to pay next month's rent or mortgage and grocery expenses. When you have it covered for 6 or 12 months, you can sleep at night. You can focus your attention on finding a new job. Your job search is not distracted by worrying about keeping a roof over your head and feeding your family.

When you begin to interview for positions again, you won't be desperate. You'll have confidence and flexibility. Desperate people often give off a whiff of desperation to potential employers in interviews. It undermines their ability to obtain a position. If the person is offered the position, the employer may offer you a lower salary if they sense your desperation

When you have an emergency fund, you won't have to borrow against your home, which may be impossible when you are out of work. You also are not forced to sell your home because you can't afford the mortgage payments anymore. Sure, you could sell your home.Consider, however, that when a lot of other people are out of jobs, home values can drop in value. You don't want to be in the position of having to sell your previously valuable home at a much lower price. This is particularly troubling if the value of the home falls below the amount you still owe on the mortgage. This happened to millions of people after the real estate bubble burst in 2008. Many people who were unemployed would have been able to find jobs elsewhere if only they could sell their homes and move. But they were so underwater on their homes, they couldn't afford to leave their home for a job in another part of the country.   

Can't Save an Emergency Fund

The  Federal Reserve reported that 40% of American adults don't have enough money to cover a $400 unexpected expense. How are they going to save up enough for 6 month's worth of expenses? 

Let's start with the people who make a good living but simply live beyond their means. I know plenty of people who make good salaries and have been broke for years. You probably know people like this, too. They usually drive expensive cars and bought more house than they could easily afford. Maybe they take extravagant vacations or they have a lot of student loan debt, too. People have to make sensible choices. Those folks need to get on a budget and see where their money is going. Get rid of the expensive car and downsize to a smaller house. Those two actions can free up a grand or two a month. If you can start banking a grand a month, that adds up very quickly.

Then there are the people who contribute so much to their retirement accounts that they don't have cash on hand. While it's great to contribute the maximum to your retirement account, taking money from a retirement account for emergency expenses later is costly. There is a 10% penalty on such withdrawals (though waved during the pandemic) and you have to pay taxes on that money or pay it back. If you take out a lot at one time, it can potentially put you into a higher tax bracket. Find a balance between contributing to your retirement accounts and having cash on hand for emergencies. Once you get that emergency fund fully funded, max out the retirement contributions again.
 
Many people don't make much money to begin with and struggle to support themselves. For those who do not earn much money, that's a huge challenge. There are a lot of socioeconomic issues at play, for which there is no solution our society has been able to come up with. Budgeting may help some, but not if you have already cut out non-essentials. Focus on earning more money. That could be from a side hustle or a new skill. Others have addressed it in detail. I highly recommend the ChooseFI podcast for many discussions on this topic.
The goal is to have an emergency fund big enough so that if you are out of a job or have a large unexpected expense, you can ride out a difficult time without borrowing, raiding your retirement accounts, being forced to sell your home or take other actions that will negatively impact your finances. 

If you are still employed and don't have an emergency fund, get started today. Conserve cash and cut out unnecessary expenses. That's easier now as there aren't many places to spend money these days. There's no telling how long that those of us who are currently employed will remain so in this turbulent economy. Being prepared with an emergency fund is the best way to manage a downturn.   

An Investor Policy Statement Helps Ride Out Coronavirus Stock Market Turmoil

The S&P 500 Index has dropped 30% or more, as of this writing, since its recent high in February. But I haven't checked my portfolio since early January. Why? I have an Investor Policy Statement that guides me through turbulent market fluctuations like this and I have more important things to focus on right now. 

Flowers at Salesforce Park in San Francisco, March 2020.

I've been in self-quarantine for a week since returning from a trip to San Francisco where I may have been exposed to the Coronavirus. My wife has a compromised immune system. As a precaution, she is staying nearby at our friends' Airbnb house that was fortunately not in use. We're focused on staying connected while she is living elsewhere during an unsettling time, avoiding contact with others so she can return home, and obtaining necessary supplies. 

The Coronavirus has disrupted life as we know it and sent financial markets into chaos. Unlike the burst financial bubble of 2008, day-to-day life has been completely upended. People are worried they or family members may catch the virus, get sick, and possibly die. Non-essential businesses are closed and people are at home, waiting for this to end.
 
I've read many posts in the financial groups to which I belong on Facebook by people complaining about how much their portfolios are down and how they are selling stock funds and buying bonds. Or they purchased stocks or funds on the dip only for the market to go lower, causing them to sell at a loss. Or they are asking what they should do. Some are too young to have experienced a bear market before and think they will never recover what they lost. How does one know what to do in times like this? 

I know because I wrote an Investor Policy Statement back in the summer. Panics or stressful situations of any kind can impair the mind's ability to make good decisions. The time to make important investing decisions or decisions of any kind, for that matter, is when you are calm, relaxed, and can think clearly, not in the middle of a crises, with the walls closing in around you. That's why it's important to make an Investment Policy Statement. Never heard of one before? Neither did I until I read this post by the Whitecoat Investor. It's basically a roadmap you write for yourself to follow for your finances rather than making decisions based on the news of the day.

Thanks to the post, I learned why a policy is essential to have and decided to document my investment decisions. I documented why I decided to invest in the funds that I did so that I would not second-guess myself when the market drops 30% or 50% or more as it did in 2008. An IPS is also for non-crisis times. It's easy to forget why you decided to invest in something five or ten years ago...or longer. That's particularly true when there is a panic and most people are running for the exits. 

So what is an Investment Policy Statement? An IPS is a document in which you write down what your goals are and how you are going reach them. They can be both financial and non-financial goals. It helps to write down why you have  particular financial goals as circumstances may change over time. You can change your goals to match. An IPS can be as short and broad or as long and detailed you like. The Whitecoat Investor has 7 sections in his policy. My IPS has five sections. It depends on your own financial situation. My plan includes:

1. Goals
2. Emergency Fund
3. Investing
4. Asset Allocation
5. Retirement Drawdown Strategy

Entire books have been written about each one of these topics. This is an overview. 


Goals

In the Goals section, I document:

• How much I want to accumulate for retirement. 
• The percentage of my income I will save each year to reach that goal.
• The age at which I want to retire or begin reducing the number of hours I want to work.  
• The expected income I will have at retirement from investments, Social Security, pension, etc.
• The kind of life I want to live and how my investments will help me to do that.

Emergency Fund 

The Emergency Fund Section is where I document:

• How many months of expenses I want to have in a bank or money market account in case of job loss or reduced income. 
• That the money is not to be invested in anything else, such as an index fund. Many people prefer to invest their emergency fund. I do not. I don't want my emergency fund to drop by 30% or more during a financial meltdown, especially when I need to live off of it. 
• This section also states that I can't use the emergency fund to go on vacation or pay for regular home maintenance costs. 

Investing

The Investing section discusses the overall investment strategy. Again, this is important to document so you aren't wondering in the middle of a panic why you made an investment decision years ago. You can review it to remind yourself. Mine discusses:

• What percentage of my income I will save and invest each year. 
• It states that I will prioritize funding tax-sheltered accounts, such as 401K, 403B, 457B, IRA, Roth IRA, etc. over taxable brokerage accounts. 
• I state that I select low cost index funds or equivalent exchange traded funds (ETFs) to reduce expenses, which are a drag on returns. 

It can also specify the investment return goal and the amount of risk you are willing to take. This helps you decide which funds you choose based on the return you expect and how much risk you can accept. If you invest in real estate or other assets, you can discuss that.

Asset Allocation

This where you get into the details of your selected investments and why. If you invest in real estate, you would include it and how much of your assets are dedicated to it. For Bogleheads like me, you might have a Three Fund Portfolio that looks like this: 

• 70% Vanguard Total Stock Market Index
• 15% Vanguard Total International Stock Market Index
• 15% Vanguard Total Bond Market Index

You may have many more investments. In this section you also explain to yourself why you are choosing this allocation. For example, I note that because of a partial pension, I have decided to choose a higher stock fund allocation than I would if I did not have a pension. A younger person may choose to be 100% invested in the Total Stock Market Index. An older person would likely have a much higher bond allocation as they are closer to or in retirement. 

This section is where you can also note how you will re-balance your portfolio. Mine will be done with new 401K contributions instead of selling and buying existing shares. I do have a provision that if the market drops by 20% or more, I may choose to sell bonds and buy more of the stock funds. At this point I have not done that. My 401K contributions are still hard at work for me, buying at lower prices. I'm satisfied with that for now.  
 
Drawdown Strategy

The Drawdown Strategy is where you write down the order in which you will draw from your accounts. Many people focus so much on accumulating that they aren't sure what to do once they have reached their goals. Had they thought about a drawdown strategy earlier, they may have planned and invested differently, retired earlier or worked even longer. You want to get this right so your money outlasts you.  

Financial planners advise that you withdraw funds from accounts in a specific order such as drawing from taxable accounts first, Roth accounts next, then IRAs, 401Ks, and similar accounts. This way you don't have too high a tax burden early and reduce the size of your portfolio unnecessarily.    

For example, you don't want to withdraw all of your money from an IRA or 401K plan the day you retire because you will pay a tremendous amount in taxes. It's best to withdraw it over time so the portfolio continues to grow and you minimize your tax burden. 

This section is where you also address when you will begin to receive Social Security benefits. If you begin doing so early, you will reduce your monthly Social Security benefit. If you wait until 65 or 67 or whatever the age is when you are eligible to receive full benefits, you will maximize your monthly payment. 

There are other factors to consider as well. If you are in good health and come from a family of long-lived individuals, you may consider delaying Social Security benefits to maximize your benefit. If you are in poor health, it may make sense to begin receiving benefits sooner, rather than later. A bigger payment later isn't useful if you aren't alive to receive it. Writing it all down, helps you see the big picture and make a plan so you aren't trying to keep it all in your head years later or when the market drops by 50%. 

The final section of the Whitecoat Investor's IPS is that all changes must wait three months before they are implemented. I think that's great advice. It prevents us from making decisions based on knee-jerk reactions to the news of the day rather than thinking of the long term. I did not include that in my written, as it's an unwritten rule for me, but will add it.

I'm optimistic that scientists will find treatments or a vaccine for the Coronavirus. Hopefully the economy recovers and people who have lost jobs or incomes will return to work quickly. 

In the meantime, I'm not panicking about my portfolio. I have an Investment Policy Statement that made sense 6 months ago and makes sense now. I wrote it for the long-term and will adjust when necessary. It allows me to focus on my work and staying healthy, rather than being distracted by every dip or jump of the market. 

I highly encourage that you write yourself and Investor Policy Statement for peace of mind when things settle down. Make  choices that will help you prepare and ride out future downturns.