Here’s a recent headline from the Wall Street Journal – Individuals Tiptoe further into the long running stock market rally.
Is that you?
Maybe you’ve done very well inside your 401K. But have you also put some money away for a rainy day or for an unexpected exceptional opportunity?
If your emergency fund is a saving’s account, it’s probably earning next to nothing. Maybe that’s an emergency! Couldn’t you find something more productive to do with that money? Perhaps one of those growth and income funds?
Okay, Stop! Put on the brakes!
What kind of car do you drive?
I don’t care what your answer is, it’s nothing compared to the Chevrolet Jimmie Johnson drives. Two years ago, in November, Jimmie drove his trusty #48 car to victory at the Homestead-Miami Speedway for a record-tying seventh NASCAR Sprint Cup championship. He drove 400 miles at about 150 miles per hour to win first place.
I use to drive a 72 Dodge Dart Swinger. Not only did it not go 150 miles per hour, I’m not sure it ever went 150 miles on a tank of gas. Should I call Jimmie to see if he’d be willing to make me a deal on his used Chevy?
The silliness of this illustration makes its own point.
But when it comes to something as abstract as money, it’s easy to drift into this kind of thinking. I call it the danger of over-optimization.
The myth is that bigger is better.
The reality is that usually balance is better. A myopic focus on “bigger” eventually gets you into trouble, remember the housing bubble, debt crisis, credit card debts, college costs…have I left anything out?
Wall Street spent a generation telling us that rate of return is where it’s at. The higher it is, the happier you’ll be, or so the story goes.
Until the reality of risk showed up and everyone started listening to that deep voice intoning at the end of all the mutual fund commercials, “Past performance is no guarantee of future returns.”
Now you tell me!
Does that mean we should abandon investment opportunities which include an element of risk? Not at all. But it does mean we should approach such risk-bearing opportunities with our eyes wide open and our balance sheets…balanced.
Emergency funds are for what the name implies – emergencies. And by definition an emergency is (a) something bad, and (b) that takes you by surprise. Investments and surprises usually don’t mix well together. A part of your net worth needs to be made up of liquid accounts whose main purpose is ease of availability in the event of an emergency, but also for an unforeseen opportunity; such as a business opportunity that may present itself.
At least six months’ worth of your annual income is what I would recommend to start.
Do you have that much cash in the bank? Do you have that much cash in a conservative permanent life insurance policy, ready to be accessible for emergencies and also for the exceptional opportunities? If not, then you’d better get a move on…at a nice, steady pace, of course.
