Investing with your safety net
Every person on this planet should have some kind of safety net. A safety net separates us from the beasts that walk around on 4 legs. If an animal can't find food when it is hungry, it stays hungry and sometimes it will starve! Oh little animal man, if only you had learned to save money for a rainy day then you could go buy some food.
It is my personal belief that you should try to maintain 6 months of living expenses as liquid capital. Think of it this way: if you cannot find a job or replenish your resources after 6 months of looking, you probably need to make some changes in the way you live your life. And by "make some changes" I mean you should start couch surfing like a college kid on summer vacation, slowly eroding friendship after friendship until there is nothing left.
In all seriousness, things happen in life unexpectedly and you will need money to float the damages. There are multiple ways to get money if you need it, such as family loans, friend loans, payday loans, selling things you cherish, etc. Maybe I can do an article on it sometime. Generally any forced sale of assets to cover living expenses is not a situation financial savvy people should see very often if ever.
Let's assume you have a safety net of 6 months all saved up. What should you do with it? just let it sit in a saving account earning .001% interest at a megabank? I mean you could do that, but I bet you would constantly be scratching your head and wondering how much money you are leaving on the table by doing so.
What are the requirements of a safety net?
- 6 months of capital saved up. (living expenses per month times the number 6)
- Funds must be liquid
- These are always post-tax calculations
Hmm liquid assets of a certain size. This reminds me of something - oh yeah that can be pretty much any liquid investment where you can get your money in less than a week or so. Stocks, Bonds, Precious metals, Savings accounts, etc
Every account that you can withdraw money from is a liquid account. I would also say that stocks and bonds are in fact liquid. Gold and silver are liquid as well - though carrying a bunch of gold around in a crisis to pay for food doesn't sound like a good idea to me, you should probably figure out how to change it for cash at some point.
The bigger issue here is that you need to maintain 6 months of capital in the account at all times. ESPECIALLY during times of economic downturn. That inherently makes your safety net more volatile than a normal fire and forget investment. You are supposed to take care that it never goes below the 6 month living expense threshold, even if the market tanks! In order to do this lets look at 2 scenarios:
100% stock safety net - Concerns and benefits
- The most recent collapse of 2008 saw the stock market lose 50% of it's value. The great depression saw somewhere of up to 90% stock market value loss.
- Normal market fluctuation is high and generally volatile compared to a savings account.
- The benefit of reaping the average stock market gain at ~9% is what you would be realizing with this method.
In order to utilize an extremely fluctuation prone asset as your safety net, you must save between 2x and 10x the 6 month value to ensure you have money on hand in a crisis. I am basing this off the DOW's 50% 2008 loss and the 90% loss of the great depression. That seems like quite a bit more money than the original 1x number, but if you want to be sure that the safety net can weather the storm you have to get there. naturally 2x the 6 month limit is an entire year of living expenses and 10x is 5 years. I have a hard time believing that anybody who is financially savvy would have 5 years worth of living expenses in the stock market as their rainy day fund, but you never know!
50% stocks / 50% Bonds safety net
Again, stocks can lose up to 90% of their value.
Yield on bonds is lower than stocks, but they are historically less volatile.
The benefit of reaping somewhere around 5% average returns is what you would be gaining with this method. No this is not an exact science.
Again, because of the volatility of this portfolio you should stay as diversified as possible. Also the amount you need to have in the account to make sure it never crosses the 6 month threshold in times of a financial crisis are varying between about 1.5x and 6x the normal 6 month worth of savings.
This reminds me of a famous section of the bible Matthew 25:14-30. In this parable a master gives a ton of money (called talents) to some of his servants. The most promising servant gets 5 talents, the middle of the road gets 2, and the lame guy gets only 1. Then the master goes away on a very long trip. When he returns he asks his servants to give the money back.
- Servant #1 - given 5 talents. Returned 10 talents to the master.
- Servant #2 - given 2 talents. Returned 4 talents to his master.
- Servant #3 - given 1 talent. Returned 1 talent to the master.
Naturally servants #1 and #2 were investing the money. Assuming around a 9% yield in the DJIA we can assume the master was gone for around 11 years which is a pretty long time. Servant #3 buried his money in the ground and had that same amount available when the master returned. Servant #3 was cast out while the other 2 were given promotions.
Let's be clear here - there is a lot of ambiguity in the bible. I personally believe that anybody who glosses over the term "talents" when in this context is missing the meaning of the story entirely. Please note that in the real world this really is how things work, the high earners and achievers get more responsibility (at least in the private sector) than those who sit idle and do not invest. It is also expected that they return more to society and to their families, and subsequently deposit more oregano their bank accounts.
This begs the question, are you servant #1 who was given much and much will be returned from him? Are you servant #2 who has less but proportionally manages his fair share to get ahead? Or are you servant #3, the guy who lets 6 months of savings sit in a major banks' savings account with .001% to show for it?