Dividends emergency fund?

Financial coaches often tell us we should have a 6-month cash emergency fund available.  When we finally build one it means there could be a tidy sum of cash sitting in a money market or bank account.  Money that’s not working for us – or not working very hard. 

The situation represents the opportunity cost of insurance.  We pay insurance companies money we have so it doesn’t work for us -- unless there’s a disaster.  With an emergency fund we pay a bank money we have so it doesn’t work for us -- unless there’s a disaster.

Is there an alternative to the “emergency fund as insurance” scenario?  Maybe.  This post referenced the possibility briefly.

What if we build a dividend portfolio generating enough income that we could lose our jobs and live off the divs?  I believe that’s known as retirement in polite company.

What happens if we build a dividend portfolio generating enough money that the cash flow covers a portion of our living costs?  What would that look like?  The following examples may be representative.

Scenario 1:  Assume an investor normally spends $5,000 per month.  Adhering to the 6-month rule means locking $30,000 = (6 x 5,000) in a bank account generating interest at the rate of one-half of one percent insuring against possible job loss.

 

Scenario 2:  If the same investor builds a portfolio generating dividends equaling 25% of her expenses, $1,250 in monthly dividend income, she requires $3,750 = (5,000 – 1,250) from her bank account each month to make ends meet.  To conform to the 6-month target, she locks up $22,500 = (6 x 3,750) at a minimal interest rate, instead of $30,000, and remains “safe”.  Now she has $7,500 = (6 x 1,250) in additional money available to work for her.

Scenario 3:  Should she build a dividend portfolio generating cash flow equivalent to 50% of her monthly needs, she requires $2,500 from her bank account to cover her bases.  Consequently, the 6-month nut is reduced to $15,000.  Fifteen thousand additional dollars are available to invest versus letting that sum deteriorate in a bank account.

This is an example of opportunity-cost thinking applied to dividend streams vs emergency funds.  Whether or not an investor chooses the option of building dividend income in lieu of an emergency fund is one of individual preference and risk tolerance.  It’s akin to deciding whether or not to be self-insured or buy an insurance policy. 

The decision may be different at various points in an investor’s life.  Early in a career when expenses are low and portfolios small, it may be better (easier?) to save 6 months’ cash in the local bank.  Later in a career, it could make sense to focus on dividend building instead of cash hoarding.  Food for thought.  What are you thinking?

The thoughts expressed here are those of the author, who is not a financial professional.  Opinions should not be considered investment advice.  They are presented for discussion and information purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.