The Stock Market Is No Place For Your ‘Rainy-Day’ Funds
Question: An issue between my wife and me is how we should invest our “rainy-day” savings of two to three months’ salary. Most financial planners recommend keeping this in money market funds so you will be sure not to lose it, and my wife agrees. But if we invested in a diversified mutual fund such as the Vanguard Index 500, we risk losing only about 20% in a very bad year--or 30% over several very bad years--and have a much better average return. So why not set aside an extra 25% or so to cover potential losses and invest for a better return?
Answer: Where on Earth did you get the idea you could lose only 20% to 30% in the stock market? Good heavens, man, read your history.
The stock market plunged more than 80% between August 1929 and May 1932, and it wasn’t until January 1945--nearly 16 years after the peak--that stock prices recovered to their former levels. The market lost more than 40% during the 1973-1974 bear market, and once again it took years for stock prices to return to their peaks.
That doesn’t mean we should bail out of stocks, especially if you’re a long-term investor. It does mean we should use some common sense about gambling with “rainy-day” money that you might need in a hurry.
People who don’t have an adequate liquid emergency fund find themselves running from one financial crisis to the next. If they have stocks, they’re often reluctant to sell, either because they’ll have to pay taxes on their winners or have to admit a mistake with their losers. Typically, they put unexpected expenses on credit cards, which means they wind up paying interest rather than earning it. That just adds to the financial stress.
An emergency fund should be kept somewhere safe and liquid, where you don’t have to worry about plummeting values or about taking a tax hit just because you need money to fix your roof--and a money market fund certainly fits that description. You might not believe it, but ask your wife: There’s an enormous psychic reward that comes from having a pot of money around.
More Thoughts on Inherited Stocks
Question: You recently answered a question from a reader whose mother had added her name and her sister’s name to some stocks. The reader wanted to know how she would be taxed once her mother died.
You indicated that the mother’s act of adding the names to the stocks could be viewed as a gift, which could prevent the daughters from getting favorable tax treatment. As an attorney, I believe the two daughters could make an argument to the Internal Revenue Service that a gift was never made. They could take the position that the mother changed the names on the certificates just to avoid probate.
Still, while their mother is alive and assuming her estate is not subject to estate taxes, the mother might want to consider having the certificates changed back to her own name, depositing the shares with a broker and listing the children on the brokerage account as beneficiaries (assuming the mother has no living trust). By correcting the title on the shares, the children could achieve more favorable tax treatment.
Answer: Your latter suggestion might be a good one, depending on how large an estate the mother might leave behind. If the mother’s estate is big enough to be subject to estate taxes--currently, more than $675,000--the daughters might be better off leaving things as they are.
Whether or not they want to “make an argument” with the IRS depends on how much money is at stake--and their own tolerance for risk. Some estate planning attorneys say they have been successful with such arguments. Many people, however, prefer to take a conservative stance with the IRS and to steer as clear of potential problems as possible.
The smartest approach, of course, is to consult a savvy accountant or a good estate planning attorney to determine the best way to hold assets. There are ways to both avoid probate--the often-expensive court process that follows death--and minimize the potential tax impact of inheriting assets.
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Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at moneytalk@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at https://www.latimes.com/moneytalk.
