General wisdom says to save at least 3 – 6 month of living expenses before working on your investments.
Many financial advisors even recommend 12 months. Good advice? Eh, maybe. For the paycheck to paycheck crowd anyway.
But if your aim is to retire early, you don’t have 40 years to invest. You need to put your dollars to work for you so they can start growing and compounding interest as soon as possible. Missing out could cost you. I learned this lesson the hard way.
Studies show that 51% of Americans don’t save an emergency fund of any size, so whether you invest everything past 3 moths of living expenses or 12 months living expenses is irrelevant to over half of Americans.
But to the other half of Americans, the difference between 3 months of living expenses in the bank and 12 months is huge. Its not a matter of if it will cost you to sit on too much cash; its a matter of how much it will cost you. The are numbers are so staggering that I consider sitting on to much cash to be one of the worst of the 7 deadly money sins.
Read on to find out how much money I cost the FI family by parking too much money in the ban.
An out-of-control rainy day fund, a cautionary tale
At the beginning of our marriage, Mrs. FI and I built up our rainy day fund within months, despite a hellacious commute for me and sky high pre-Great Recession gas prices. By the end of one year, we had over a year’s living expenses saved, despite my $17.00/hr job and Mrs. FI’s even lower stipend of $9,000/year as a graduate teaching assistant. Though our expenses, wages, and family would expand in the coming years, we would never once drop below 12 months of living expenses in the bank.
At times, like during Covid quarantine, we even sat on as much as 5 years living expenses. I often joked that I was like Uncle Scrooge in Duck Tales, who only felt secure when he was swimming through a sea of gold coins.
I could give a lot of excuses for this costly mistake. The poverty living I had to sustain to pay my way own through college, resisting lifestyle inflation, company bonuses toward the back end of my career, not checking bank records, laziness; all valid reasons.
But the main reason why I left too much in the bank is because I assumed I would be working until I was 59 1/2 and I knew my retirements investments were well on track as Mrs. FI and I were both maxing out 401k contributions in low cost stock index funds.
I thought non retirement “investment” was only for rich and privileged people, so building an early retirement nest egg in taxable brokerage account was not something I had even considered possible. Boy, was I wrong, and boy, did it cost me.
Below is a brief summary of the FI family cash position over the past 15 years, followed by an analysis of how much this cost us in lost opportunity by staying out of the market. The results still boggle my brain to this day.
Cash on hand History
By year end 2009 (3 years full time employment), Mrs. FI and I had a combined annual income of ~$70K, and had managed to save ~$95K. We put $50K toward our first house down payment. The $45K leftover was about 18 months of living expenses. Over the next 6 years, we made extra payments in 2 x yearly lump sums on our house until we were debt free, but never once dipped below 12 months living expenses.
Once debt free in 2016, our cash hoarding got even worse, I am ashamed to say. By 2018, we starting sitting on over 6 figures in cash in a checking account (still maxing out 401ks and IRAs at least).
Even after upgrading to a nicer home in 2019 (debt free), we still continued to park cash, and by 2021 we had over $200K parked in a checking account.Stupid. Patently stupid.
I awoke from my college poverty fog at that moment, deeply dissatisfied with my stressful career, investing all but 3 months emergency expenses in our first taxable brokerage account to start funding an early retirement plan. A short time later, I would come to realize that after one more year of work I would comfortably surpass my FI number, despite all of the investment opportunities I missed out on over the past 14 years.
So How much did it cost the FI family
A boatload! It cost us at least $182K in lost opportunity just for being foolish enough to sit on cash for a little over a decade. Expressed in work years, this sum of lost investment return equates into at least 2 more years of work for Mrs. FI and I to reach financial independence.
Let’s run through the math. I could have invested $50K in February 2009, still had 3 months of living expenses, and still been able to make all of the same down payment and debt payoff activities in the future that I summarized above.
Say I bought $50K of the VTSAX Total Stock Market Index Fund at that time. Its price was $20.12 per share. As of this writing, in the 2022 bear market where the stock market is down 20% (in other words we are measuring valley to valley), VTSAX shares go for $93.73. That is an insane 465% increase in value! My initial $50K could be worth $232K today, and that doesn’t even include if I had also reinvested the dividends over those 13 years.
With $182K, I could have hit my FI number in ~13 years instead of 15 years.
I’d love to go back in time and tell that naïve recent college grad that he doesn’t need to sit on so much money to be secure. That he has worth. That even if he loses a job, he is resourceful enough to find a new one. That his family will love him unconditionally no matter how fat his wallet is. That its more responsible to invest than not to. That he could shave years off his working life by investing instead of holding.
But life doesn’t give any of us a do over. If you are early in your FI journey, I hope this message reaches you in time to steer you on the more profitable path. Don’t make the money mistakes I made. I hope your journey lands you at your FI destination faster than it did me.
The delicious irony of this wasted opportunity and way-over-invested security . . . Mrs. FI and I never once had to invade our precious rainy day cash hoard in our 15 year journey to FI. Not once.
If you are sitting on a large rainy day fund, run the math against a potential investment return and your projected FI date, and see if you are missing out on an opportunity. Let me know in the comments below what you discovered.