For the ‘fully invested’ crowd: if you are growing your investments, 3-6-12 months of expenses (whatever your comfort zone) becomes less and less of your net worth, so it affects your ROI less each period. Of course, on the flip side, having to liquidate part of the trust fund becomes less of a hit also, even if the market has dropped 75%.
But it’s the “market has dropped 75%” scenario that keeps some amount (probably too much, but my wife is risk-averse) of the hoard in cash. I’m trading some unknown gain for insurance against selling at a loss.
I also like to have cash in hand for those market drops. Then I buy dividend stock. So the dividend portion of my portfolio has 8-9% dividend yields on its original purchase price, plus gain. If I sold, I’d buy back fewer shares and take a dividend hit.
Now, if I have all my cash in the market, I can’t take advantage of fire sale prices on dividend stock - and I have to sell my dividend stock, cutting into my dividend income.
Machine elf–yep, totally agree, and in fact I had that realization myself in the shower this morning.
Also, a couple of people have said that I may be forced to “take a loss” when I don’t want to. That’s a bad way to think about investing. If you buy something for $100 and it’s now worth $75, you’ve already lost $25 whether you sell it now or keep holding it.
Also, I understand those of you in volatile employment fields–I can see how having csh makes sense there.
Paper losses are different than actual losses. I’ll take losses when I want to (and I often do if stock isn’t performing or if I start to get to emotionally invested in the loss - that isn’t good investing), but I don’t like taking losses cause I NEED to. I want the market to work for me - it isn’t doing that when circumstances are forcing my hand on when to sell.
I think what they’re saying is that it’s all theoretical until you actually sell the instruments in question.
For example, if you had a share of stock X at $20.00 in 2007, it dropped to $5 in 2008, and by 2011 it’s back to $20.00, you neither lost nor gained over your four year period on that particular stock.
You’d have lost if you sold it before it was back at $20.00 though, but since you didn’t, that $15 loss in 2008 was a paper loss.
So what she’s trying to say is that by not putting the savings money into stocks, the only value loss you have to deal with is inflation, rather than potentially having to incur losses if you convert your stocks to cash when they’re down.
Right, but you’re just illustrating my point that “paper losses” and “real losses” are the exact same thing. Really the decision to not sell something is a decision to buy it. The past has already happened and can’t be changed.
Paper losses are different in the obvious way that they have not been realized. I do not know if you are a fundamentalist or a technicalist (or combination), but clearly if you believe in fundamental analysis then you can believe that the intrinsic value of a security exists despite some market pyschology change.
Well, they haven’t been realized in the tax sense, but they have in the economic sense.
If you have $10k and lose $2k at a casino, then you now have $8k. Also, if you buy $10k worth of stock and it goes down in value to $8k, you also have something worth $8k, exactly as in the first scenario. The first scenario becomes the second if you use the $8k to buy that stock.
In both those cases you are willing to take some risk on your bankroll because you believe that the trend will be up even if there are fluctuations down. If that’s your emergency fund and you have to take out $4k right now, you will be left trying to ride out that fluctuation where you lost $2k with only a $4k bankroll. That 20% downturn in the market needed a 25% rise to get you whole if you still had the whole bankroll, but now you need a 50% rise to get back that $2k. You were banking on the market trending upwards eventually, but by cashing out part of your bankroll you are going to have a hard time recovering from that loss. Obviously if you luck out and are forced to cash in during a peak instead you’ll be locking in profits instead of losses, but if you are investing you should be the one dictating the timing, not an emergency.
I think some people are losing sight of the discussion here. The issue we are discussing is whether to make the investment or hold onto the cash. If you choose to make the investment, then of course you only make an investment you think will go up, and of course it may go down, and of course you may be forced to liquidate when you don’t want to. But, you wouldn’t want to spend the cash either if you just kept it in cash–that’s just the nature of having to spend money in an emergency.
Making the investment gives you the opportunity for gain, whereas cah doesn’t. Of course, the investment also carries the risk of loss, whereas cash doesn’t. But you choose the investment by balancing the two and picking one you think will go up. If it goes down and you have to sell, then that’s just a risk you take.
I guess another thing that should be mentioned here is that you really shouldn’t count 100% of the investment as an emergency fund because it could go down in value. So, if you want a $10k emergency fund, you should have something like $12k or whatever invested.
There are numerous reasons why cash or cash type instruments have value.
Cash is better than unused borrowing capability because that unused availability can be taken away. It may be unlikely to occur, but it can happen.
Cash allows you to take advantage of buying opportunities that come up unexpectedly.
Cash can help with unexpected catastrophic expenses. You may simply not want to liquidate other investments (for a multitude of reasons).
Cash serves as an unencumbered cushion in the event that you lose your revenue stream. Regardless of how secure you think your income stream is, you can lose it.
The very simple fact is that lightning can strike. Something unexpected always has the chance of occurring.
Take a look at some company balance sheets. Most retain cash despite also having some unused borrowing capacity.
It probably makes a big difference what your overall net worth is.
If you have a net worth of $3M invested in the market (and fairly affordable day to day needs), than who cares if $1M of it disappears overnight. You can still manage to have plenty of cash in your hands to meet your needs for some amount of time if you loose your job- even with $50 in your checking account and nothing in savings. (I’d still keep more cash liquid myself, but that is me)
But if you have $3000 in the market and $50 in the checking account and nothing in savings, and suddenly $1000 disappears overnight, that’s going to hurt if you have any significant financial emergency and need that money.
I’m surprised you haven’t mentioned this (since you are a tax attorney), but if you are forced to liquidate stock you purchased at $10k at a $2k loss, you can write off some off that loss on your taxes. If you pay $2k in cash, you don’t get to write that off (unless of course whatever you are forced to pay for qualifies as a deduction, in which case it is a wash in both scenarios).
There are also tax implications if you plan to invest that money. Say you are saving up for downpayment on a house you want to buy in a year. You need to take into account any capital gains you may incur when you sell those stocks. It might work out that it would have been better just to keep it in savings.
It’s not the exact same. It may be the same from a current liquidation value perspective, but that stock may have intrinsic value above that which hasn’t been captured by the market value yet.
Do you believe in a perfectly efficient market? When you buy a stock, do you buy it because you believe it is undervalued? Do you ever sell a stock because you think it is overvalued?
The value of a stock right now is the amount you can sell it for right now. The "undervalued"concept is just one way to say “I think the price will go up in the future.” The stock is not uin some present state of “being undervalued.” There’s no “real value” that’s different than the current market value.
Sure, assuming the market will be up. Once you assume that, obviously the best move is to invest every last dime in it. Once you remove that assumption (and it’s not a good assumption to make in this case), then the right move is not so obvious.
Something to consider: On average, you are statistically more likely to need your emergency fund in a down market. You can wreck your car or have a medical emergency at any time, but losing your job and being unable to get another one (or being unable to get as good of one) is more likely to happen when the economy is faltering and the stock market is down.
Transaction costs also play a more significant role when you are dealing with fairly small amounts of money. This is especially true when we are talking about “rainy day” savings, not retirement-or-huge-emergency savings.
I move money in and out of my savings account a lot: I move money in a couple times a month, and I pull money out of it several times a year. We “save” every penny above basic operational costs, but I am not shy about dipping into those savings if we need to buy a new appliance or take a planned vacation or deal with other non-reoccurring expenses. It would be a real pain in the ass to have to liquidate something because the dishwasher broke. It’s just not worth it to me to have to worry about that: I’d rather have the cash on hand to handle those sorts of expenses.
There are also times when you can’t project future expenses very well. We have a Big Pile of Money in savings right now because we are having a baby in October. It’s just really hard to project what that is going to cost, beyond “way more than we think”. So for now, we will just keep adding to the Big Pile, and six months after the baby is born we will look at what is left, what our new level of “normal” expenditures looks like, and reassess. But even then, I want to be able to handle unexpected mid-level expenses without a lot of bother.
Yes, there is. Apparently you think you know more than people like Adam Smith, John Maynard Keynes, and Warren Buffett though. Maybe, instead, you could read a beginner’s book on Fundamental Analysis and educate yourself on the topic instead of spouting off obviously incorrect platitudes. I guarantee you that there is not a single company you invest in that believes what you just stated.
I think it’s reasonable to argue that the market was significantly less efficient when Keynes was a hedge fund manager. And Buffett recommends index investing.
I think the point is, unless you’re a big bank and can suspend mark-to-market accounting of your positions, you are SOL. It doesn’t matter what you think your portfolio is worth. It’s is worth exactly what the current market price is. Even if there is a very solid rational reason you believe your securities are mispriced, you can do nothing to realize that value until the market agrees (if ever).
Also, there is no 100% agreed upon model that can be used to determine a stock’s true value. For every fundamental argument explaining why a stock is over valued, you could find another fundamental analyst arguing the opposite.