Compare putting money aside to keep as an emergency fund in a vehicle that will not drop in value even in the event of a market crash vs investing the same money in the market. Assume that for some time the value of the investment grows, however at the end of the observation period it drops significantly from whatever value had been achieved, and at the same time you need to withdraw the funds.
If the difference in yield between the investment and the emergency fund is x % and the drawdown is y %, what’s the time horizon before the return of the investment strategy exceeds that of the emergency fund strategy?
For example, for a drawdown of 50%, the balance on the investment would have had to double that of the emergency fund, which can be approximated using the rule of 72. In other words, if up until the crash the investment was earning 5% per year over the emergency fund, the breakeven point would be 14.4 years.
Such calculation may help someone decide between keeping an emergency fund or not. Decision would be individualized though, as two people may agree on what the chance of a 50% market drop is, but they may differ on their likelihood of needing the funds at that time (their employments may be more or less vulnerable to layoffs in market downturns). Of course, someone may decide to keep an emergency fund for non-financial reasons i.e. if it helps them sleep better at night.
If the difference in yield between the investment and the emergency fund is x % and the drawdown is y %, what’s the time horizon before the return of the investment strategy exceeds that of the emergency fund strategy?
For example, for a drawdown of 50%, the balance on the investment would have had to double that of the emergency fund, which can be approximated using the rule of 72. In other words, if up until the crash the investment was earning 5% per year over the emergency fund, the breakeven point would be 14.4 years.
Such calculation may help someone decide between keeping an emergency fund or not. Decision would be individualized though, as two people may agree on what the chance of a 50% market drop is, but they may differ on their likelihood of needing the funds at that time (their employments may be more or less vulnerable to layoffs in market downturns). Of course, someone may decide to keep an emergency fund for non-financial reasons i.e. if it helps them sleep better at night.
Statistics: Posted by _M_ — Mon Oct 21, 2024 9:13 pm — Replies 1 — Views 251