Financial planning 101 - Step 4 - Emergency funds
The continuing series around financial planning 101.
Step 4: Emergency fund
Why emergency fund? As the name suggests for emergencies. We have probably seen countless movies where kids break their piggy bank for emergencies. This is essentially the adult version of the same. Instead of a piggy bank that you break, you plan for it.
How much do you need?
The recommendation is to have 3 to 6 months worth of monthly expenses as an emergency fund based on your level of comfort and your risk level. Note, I mentioned expenses not income, Your monthly income might be much greater considering savings and investments, but the important thing is to ensure that you are able to tide over emergencies for an extended period without touching your investments.
Where do you keep it?
The easiest answer is to just leave it in a savings / checking account. But given the extremely poor interest rate of these products, you might feel bad about leaving them there. In Singapore most banks have higher interest bearing accounts which provide slightly better returns than the 0.1% interest per annum.
Higher interest bearing accounts
All these higher interest bearing accounts yield 2 to 4% interest , but you will have to jump through some hoops to get the additional interest,
by holding some minimum in the account
Minimum credit card spend
Mortgage with the bank
Invest in banks’ insurance products
Invest in banks’ investment products etc.
Some or all of these above points need to be satisfied for you to get additional interest. If you are able to meet these conditions and the ability to keep these holding decoupled from your regular accounts then more power to you.
SGS - Singapore Government Bonds
The second option is to invest in Singapore government bonds. These are sovereign bonds backed by Singapore government one of the few AAA rating bonds that are available to retail investors easily in Singapore. The returns are slightly lesser between 1.6 to 2.2%, but they are easily convertible and you can sell them back to the government in case you need the money quickly.
The advantage of keeping your emergency fund here is that it is not directly visible via your bank account and the temptation to use the funds into other investments or worse still spend them is lesser.
Robo advisor
There are a lot of robo advisors that have cropped up in Singapore now. They offer an option to invest in international funds and you can choose the level of risk that you are comfortable with. You can setup an emergency fund goal and decide to invest only in debt based instruments by choosing the most conservative option.
To name a few. You can use any of these to invest your emergency funds.
Staggered
Another option worth considering is to split the investments into even smaller buckets.
Immediate emergency - 1 or 2 month expenses
Medium term emergency - next 1 or 2 months expenses
Longer term emergency - next 1 or 2 months expenses
You may choose to invest the funds in these three baskets into 3 different products as required.
I am a fan of this approach,
keeping the immediate emergency in high interest savings account
Medium term with SGS government bonds
Longer term emergency in robo advisors
But remember to not invest any of these in equity products, the last thing that you need is to need the funds during a market crash.
My situation
I have to admit that I don’t have the entire emergency fund saved up. It feels wrong to leave this amount in low interest bearing accounts / products. But I am resisting the temptation to put this into equity and using the staggered approach detailed above to build my emergency fund. I am almost half way there, aim to have the full amount ready by mid 2020.
Conclusion
Emergencies are essentially the “unknown unknowns” that you cannot predict but can plan for to some extent. It can be a broken refrigerator, a minor accident, job loss, an unexpected expense in the family, whatever maybe. To know that you have saved up enough to tide you over that emergency, will remove the stress and anxiety around the emergency. The peace of mind is the price you pay for the poor/no returns that you might see against the emergency funds, but it is a price that is worth paying.
Happy Investing, up next
Step 5: Insurance