Saving for Rainy Days

I fondly remembered my primary school days when my mother would give me a dollar a day for pocket money. It seems like very little now, but those days it was enough to get through lunch and still have money left for some tidbits after class.

And then there was this $2 note which was perpetually hidden in a little-used compartment of my nylon-and-Velcro wallet. This was my 'spare money'. Money to be used when my pocket money runs out, and I need buy something urgently.

I couldn't just spend the money as I wish though. To top up the spare money, I would need to account to my mother what I spent on and whether it was necessary. She is probably the most frugal person in the world and getting past that inquiry wasn't exactly easy.

The money was hardly used though, simply because it was so hidden that I often forgot it was there. But it was always there, always ready to save me in times of emergency.

I am grateful that since young I have been inculcated this habit of responsible spending and prudence. Till today I always have 'spare money' in a separate bank account. I have also purchased assets that can be liquidated within a week should I require additional cash flow.

In the course of my career as a financial planner, I see a lot of young people overspending and racking up debts on credit cards and micro loans. Another large percentage of people on the twenties are usually just-above-broke in their bank accounts. When times get tough, they are forced to put aside their pride and go around borrowing money from friends.

This could be resolved quite simply by having an emergency, or 'rainy day', fund. Here is how to set it up.

Step 1 - Know your monthly expenses

Firstly, calculate your basic monthly expenses. This includes your fixed expenses (e.g. loan repayments, insurance premiums, bills, etc), personal expenses (e.g. transport, food, etc), family expenses (e.g. parent's allowance, utilities, groceries, etc).

Step 2 - Multiply by 3

Once you have the amount, multiple that figure by 3. The idea is to start by setting aside 3 months' worth of your expenses. This will buy you 3 months of breathing space when times are tough.

Step 3 - Stash it somewhere safe

Take this 3 months' worth of your expenses out from your bank account, and open another bank account with it. Ideally this new bank account should not have an ATM card. If you don't have enough to meet the minimum for account opening, stash your rainy day fund in a tin can and continue saving every month until it is enough to open a deposit account.

Step 4 - From 3 to 6

Every month, continue saving a portion of your income (say 10%)  into this fund, until you reach 6 months' liquidity. If you work in a career whereby it is difficult to find a new job immediately, or if you are in business, you may want to set aside a year's liquidity.

When the amount gets larger, you may put this money in a fixed deposit account.

There it is, you have your basic liquidity. It is recommended to always have at least 3 - 6 months of basic liquidity.

Step 5 - Invest the rest

Once you have the 6 months in your rainy day fund, the rest of your future savings should be channelled into liquid assets that you can easily sell off within a week should you need the money. Such investments include shares of good companies, unit trusts (mutual funds), or even physical gold bullion.

Aim to have another 6 months worth of such liquid assets. This will form your standby liquidity. 

Step 6 - Monitor and review

It is important to also keep your expenses in check. The fund should be increased when your spendings increase, so that it is adequate to bail you out in times of emergency. Review your finances at least once a year to ensure that all areas are working in your favour.

With 6 months of basic liquidity (cash and cash equivalent) and 6 months of standby liquidity (liquid assets), you have a total of 1 year's security. This will prevent you from being unable to pay off credit card balances, loan repayments and having to borrow from friends.

After you have built your rainy day fund, you may then channel the rest of your savings towards medium to long term investments and focus on building wealth.

Remember to keep everything systematic and disciplined. Good luck!