Last month, I read about an interesting concept at Get Rich Slowly – The Opportunity Fund. The opportunity fund is basically the money you set aside to take advantage of opportunities. Once in a while, you’ll come across a good opportunity and you need money to take advantage of it. These opportunities can be anything from a chance to travel to Iceland with friends or investing in the stock market when the price is low. But where does the opportunity fund sit in your portfolio? Should it be in cash or something else? Today, we’ll see how to build your opportunity fund and where it should be in your portfolio.
Before we look at the opportunity fund, we’ll need to go over the emergency fund quickly. The emergency fund is money set aside for those financial surprises life inevitably throws our way. Nearly half of Americans can’t come up with $400 in an emergency. That’s living close to the edge. If the car broke down, they’d need to put it on the credit card and pay it off over time. This is a slippery slope because the balance on high interest loans tend to keep increasing.
This is why we all need an emergency fund. If you have a stable job and good cash flow, then the emergency fund can be a smaller amount. Personally, I like to keep about $10,000 in our reward checking account for this purpose. The $10,000 can cover 2 months of expense and it should take care of almost any emergency for us. If we need more cash, we’ll raise it by selling some investments.
I also keep an eye on upcoming big expenses. For example, we pay our property taxes in October and that’s a 5 figures bill. When I know there is a big bill coming, I increase our cash fund by that amount. So by October, we need to have about $25,000 in cash.
The opportunity fund concept is very intriguing to me because I couldn’t capitalize on past opportunities. During the Great Recession, the stock market crashed and I didn’t have much extra money to invest. Our portfolio was 100% stocks and it plunged like everything else. The only way to invest was to save as much of our income as we could, and invest that.
We powered through the Financial Crisis because we both had good stable income. We kept investing through it all and didn’t miss out on the recovery like many investors did. I think we could have done much better if we set aside some money in an opportunity fund. We could have taken advantage of the opportunity to invest more when the stock market was down.
Life has changed quite a bit since the Great Recession. Now, I’m a stay-at-home dad/blogger and my income is very uncertain. My blog income was incredible in 2017, but I’m sure it will drop like a rock when a recession strikes. Mrs. RB40’s income is great right now, but she plans to retire early by 2020. Our income is much more tenuous than in 2008. If we don’t plan ahead, we won’t be able to take advantage of the next big opportunity to invest.
Building Your Opportunity Fund
How do you build an opportunity fund? Here is a diagram I made. Our opportunity fund is split in a few accounts. Part of it is in our saving account and the rest is in money market funds.
We put our income into our bank accounts as they come in. This will shore up our emergency fund and there should be $10,000 to $20,000 in that account. Anything over this amount will flow into our opportunity fund. New money will trickle in from this side every month as long as we don’t have unexpected expenses. Your income needs to consistently exceed your expense for this part to work well.
On the other side, we have our investment. I split them into two boxes – bonds and everything else. Our target asset allocation is 20% bond and 80% everything else. As the stock market gets overheated, I plan to shift some stock investment into the opportunity fund. My goal is to increase our opportunity fund to about 10% of our portfolio value. So it to be 10/20/70, opportunity fund/bond/everything else.
Yes, this is market timing. It is similar to Value Based asset allocation. If the stock market is overpriced, then shift some allocation to bond and cash. The US stock market valuation is very high at this time and the expected return is low for the next decade. Many experts predict 4-5% annual gains. That’s much lower than 21% we got in 2017. Nobody knows what the stock market is going to do, though. It could grow slowly over the next decade. Or it could keep shooting up and crash.
The global economy is doing so well and consumers are very optimistic. I think 2018 will be a good year on the stock market. We had a correction in January, but it is recovering quickly. I suspect the stock market will keep going up while the global economy looks this great.
Here is the CAPE ratio. This looks scary to me. The S&P 500 index is approaching the dot com era valuation and we all know how well that turned out.
Do you have an opportunity fund?
New investors shouldn’t worry about the stock market fluctuation. When you’re starting out, you should focus on increasing your saving rate. Older investors who are nearing retirement have to be more conservative. I think increasing our bond/cash allocation a bit is a good idea for us. We’ll have better access to cash. 10% isn’t a huge shift so it won’t screw up our long term plan even if I’m wrong. Also, it will give me something to write about. We’ll see how it plays out over the next few years.
What about you? Do you have an opportunity fund?
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Image by Christian Spies
Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!
Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.