Fidelity: Retirees likely don't need an emergency fund

Investment Analysis Clubs Macro Economic Trends and Risks
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The fixed income portion of your Retirement Portfolio is likely more than enough.

https://www.thestreet.com/retirement/fidelity-challenges-retirement-emergency-savings-rule

Even though I’m 97% stock, the 3% in bonds and cash is 10 years’ worth of living expenses (prior to starting SS last year) and more than enough to replace an automobile or my home. That’s why I don’t have collision and comp on my automobile and only insure about 10% of the value of my home, just enough qualify for liability coverage. As my Casualty Actuary little brother explains, if you can shoulder the risk, there’s no reason to add the expense and hassle of dealing with an insurance company to a claim for a loss.

intercst

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I mean - this isn’t really a surprise. The self-interest is right there on the tin.

For the money that you need to keep around to cover unexpected expenses, Fidelity recommends that you buy the sorts of assets they sell. Don’t keep that money in a bank. Keep it in your Fidelity brokerage account - in a bond portfolio that we’ll sell you!

(Don’t worry about the fact that bonds can also sharply lose value in extreme events. Sure, the Fidelity total bond fund collapsed 20% in the interest rate hikes following the pandemic. But that could never happen again.)

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Long-term bonds tend to be a bad investment. I’ve kept my duration in the 1-2 year range and dropped about 5% during the pandemic.

Then other thing you need to understand is that this is a noncorrelated, contingent liability calculation. The bond market is unlikely to drop on the same day your car is stolen and home set ablaze. And even then, if you have a Pacific Palisades like disaster where all is lost, the insurance company will redouble their efforts to cheat you out of the coverage you paid for.

Lot’s of moving parts in the calculation, and like “rent vs. buy”, even people who think they understand the arithmetic get it wrong and are paying for insurance that offers little relief.

Owning a home is a poor way to build wealth, and buying an insurance policy isn’t patriotism and good citizenship. It’s a financial product with a high skim rate that you should avoid if you can afford to.

It was interesting today at the Tesla dealer when I picked up my loaner vehicle. They wanted to take a picture of my insurance card, which clearly shows I just have liability coverage and no collision & comp. They didn’t question it. I guess I’m not the only customer doing the arithmetic.

intercst

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You don’t need to buy a Fidelity bond fund. Lots of retirees keep their fixed income in a laddered portfolio of FDIC-insured CDs. Fidelity is just accurately explaining the arithmetic that the actuarial profession has understood for years.

intercst

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I didn’t mean literally that the only vehicle for doing this is a Fidelity bond fund. Just that this article is encouraging people to buy financial products instead of cash. Fidelity is in the business of selling financial products, on which they earn a profit. So there’s a clear incentive for them to advocate buying financial products generally. You’ll note that they didn’t mention laddered CD’s in the article. They’re talking their own book, even as they’re touching on general financial advice issues.

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Fidelity brokers FDIC-insured CDs and even has a section on how to set up a ladder. Anyone who buys fixed-income products needs to understand how the value of the product, whether CD or bond fund, will change when prevailing interest rates change. Bond funds are bad if interest rates rise because the NAV will fall and it’s impossible to hold to maturity for return of principal.

Wendy

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It may be different in the USA (I’m in the UK) but we paid about $60k for our bungalow almost 40 years ago. Now worth about $500k and no rent paid for the last 40 years.

Seems a great ‘investment’ to me.

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$60k invested 40 years ago in an Index that averaged 10% annually would be worth pre-tax $2.7mil.

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Yes, but someone (usually) has to live somewhere and pay for that. Over time, what amount of that $60k would have been spent on rent or a different mortgage v. investing it all in an index?

Pete

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I don’t disagree. There are other factors that would come into play, including the ability to take money otherwise spent on rent and dollar cost average into the market. Having said that, looking purely at the purchase of a home in this example as an investment vs say letting one’s money work in the market, the latter would have produced a much higher result. It is an example of the opportunity cost that comes with large one time purchases.

One of the concepts in the US that I would l to see ended is the emphasis on home ownership as a goal of achieving the American Dream. It should be financial freedom without the shackles of debt.

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Home ownership is the single largest driver of generational wealth. Property passes to decedents more frequently than income does. Home owners have a significantly higher net worth than renters (the latter may be more correlation than causation as ownership simply is not affordable for many).

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Property passes more frequently because for most it is their single largest asset. Homeowners have much higher median incomes, almost twice that of renters. Excluding the home from net worth, home owners have net worths on average that are 10x higher. In addition, most home owners are also married or in long term relationships which allows for the sharing of costs and pooling income.

In other words, home owners aren’t better off because they own homes. They are better off because as a demographic, they tend to make more and save more. The form in which they pass that on to the next generation seems immaterial, whether parked as value in a home or other assets.

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40 years growth at 10% - dream on :slightly_smiling_face:

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You’re right, it’s actually higher.:wink:

Over the last 40 years, the S&P 500 has delivered an average annualized return of approximately 12.74% (with dividends reinvested). This long-term period of wealth generation has seen multiple economic cycles, surviving major bear markets while being driven primarily by the steady long-term compounding of U.S. equities. [1, 2]

The benchmark index has undergone a mix of massive bull runs and notable market downturns over the last four decades:

Key Milestones & Annual Averages

  • Annualized Return: ~12.74%
  • Average 20-Year Return: ~12.39%
  • Average 30-Year Return: ~11.80% [1]
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Retirees using the 4% rule have plenty of assets and good credit rating. They can deal with most emergencies w a credit card. That gives time to sell securities to fund the need.

The emergency fund point does not refer to well off TMFers. But those just getting by on say Social Security and small pension should be aware. If you have assets, not a problem. Those without assets have to plan ahead.

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Maybe 10 years ago I read an article, somewhere, that if you needed $X in your emergency fund, and you could afford 30% higher than that, then put 1.3 times $X into a balanced ETF instead of a money market, CDs, etc. The point being the ROI is much higher, and if you had an emergency during a bear market you would have time to sell out before a full 30% decline in NAV. Implying you will never have less than $X in your emergency bucket.

I could never convince myself to do that however. For one, when you need the emergency funds, you are selling an investment, and that incurs a capital gain tax event. For two, if you suffer a 20% decline in NAV do you sell out in the event you need to tap your emergency fund before it dips more than 30%? And when to get back in again?

Liquid, non-tax-event money markets seemed the better approach then, and still today, to me. I’m going to guess I will feel the same in retirement. I hope to find out sooner than later about that.

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Correct! albaby doesn’t like it. But here’s the actual result of my decision to “rent vs. buy” when I moved from New York to Houston in 1981. My 1981 rent of $400/month dropped to $200/month in the 1986 housing crash in Houston. It took until about 1997 before the rent returned to $400/month and another 20+ years before it doubled again to $850/month on 2021.

{{ When I moved to Houston from New York in 1981, I rented a 600 SF unit in a large garden apartment complex less than a mile from the Galleria Shopping Center for $400/month. The owner was in the process of turning half the property into condos. A 600 SF condo was selling for about $45,000 at the time. Mortgage interest rates were around 14% in 1981, but with itemized deductions and a high enough salary, after tax, the monthly cost of owning was about the same as renting.

Today (2021) that 600 SF Houston Galleria area condo sells for about $100,000 and the 600 SF apartment rents for $850/month. If you put the 20%, $9,000 down payment on the condo in an S&P500 index fund over the past 40 years, you’d have $693,000 today and the 1.6% dividend yield (about $11,000/yr) would more than cover the $850/month apartment rent.

I lived off and on in Houston for 25 years before I fled Texas for Washington State in 2006. It was a marvel to observe the low housing costs in the city. As REITs continued to build new apartment complexes as far as the eye could see, my monthly rent barely budged. When I left town, I was paying less than $600/month for a 900 SF unit in an apartment complex with several pools and tennis courts. I guess real estate developers are going to develop, and builders are going to build, as long as investors keep throwing money at them. }}

albaby says I’m, “Market timing the housing market” I don’t know? If I go to an auto dealer and run the numbers between purchasing a car and leasing it, am I “Market timing the auto market”? I don’t think so. There’s nothing special about a home, I’m just purchasing “housing services” for the best deal – rent or buy.

The other point albaby will make is that Houston condo only appreciated at 1% per year while the real estate average is 4% per year. But that’s my whole point. I have no way to guaranty that I’ll be getting the 4% average real estate market return on an individual home purchase. There are lots of homes in nice neighborhoods that produce inferior investment returns. But you’d need to do a rent vs. buy analysis to know that. Purchasing an index fund gives me a better return over 30 years than 95% of professional money managers. I can’t guaranty myself the same result with a home purchase. The “skim” is too high.

intercst

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I quit working way back in 1994 at age 38 to live off the “4% rule” from a stock portfolio. Over that time the S&P 500 has grown more than 20-fold with dividends reinvested (i.e., $1 million is now $20 million)

Of course, if you were withdrawing money for living expenses each year you have less, like maybe 10x or 15x depending on how you were invested. But it’s still a bundle.

intercst

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To me, emergency fund is mostly abt working family that may lose job and be unemployed for six months. That requires assets but not immediate cash. Worst might be son or daughter involved in accident. I think $10k or so in immediate assets is enough. The rest can be in securities. Of course you have market risk, but not a large concern dealing with an emergency.

Retirees have a whole different situation. Very different if you are retired on assets.

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I’m sure no one needs us to rehash the “rent v. buy” debate in another thread, but you end up running some of this risk either way - because rents and prices are very highly correlated.

For simplification, we often ignore future housing payments in the rent v. buy scenario. We assume that your monthly out of pocket will remain the same, or will even out over time. In the rent scenario, you pay $X per year in rent; in the buy scenario, you pay $Y per year in mortgage payments. We assume that X and Y, either in the moment or as they accumulate over the life of the competing investments, are roughly the same so that we can ignore them for a CAGR calculation.

But that’s not true in the real world, of course. IRL, the cost of mortgage servicing remains roughly constant (barring a refinance), but the cost of rent rises over time.

This matters a lot to your wealth, because for nearly all folks for whom a “rent v. buy” calculation would relevant (ie. people who have a choice), the capital that they put into either a home down payment or the stock exchange will never be their only investment. They’ll invest $Z per year going forward as well. But $Z is affected by how much they have to pay for housing - probably the single biggest expense. So if a family has $50K left over after all their non-housing expenses, then their $Z - the amount they can put into the market - will be $50K - $X (rent) or $50K - $Y (mortgage).

In markets where rents and prices are rising faster than the norm, renting ends up being the worse choice for two reasons. The obvious reason is that the initial capital you deploy will be relatively worse off compared to had you invested it in housing, because of that price appreciation. But the other reason, which we don’t discuss in simple rent vs. buy calculations, is that you will have less money for all your future investment, because you have to pay more for housing on an ongoing basis as well.

There are pros and cons to both options. The primary advantages to putting your initial capital into a stock investment rather than buying are a much higher expected rate of return and much lower transaction costs. The primary advantages you get with purchasing a home are:

  1. Access to low-cost leverage;
  2. Advantageous tax treatment; and
  3. Insurance against future increases in the cost of housing.

None of those are small, though the second has declined in importance with changes in the tax code. From our discussions, I think you didn’t include any of them in your rent/buy calculations - which might explain your perspective on these things. But #3 is relevant to the riskiness of your overall assets. Buying a home exposes you to some additional risk of variability of long term returns (home prices are far less volatile over shorter periods, which has some advantages, but we’re not going to get into Sharpe ratios here), but it reduces your exposure to the risk of rising home prices. It’s an insurance product - and unlike most insurance, no skim to an insurance company!

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