Set up rainy-day fund before investing

Given uncertainty and higher costs of living, experts advise saving 6 to 12 months of pay
01 Apr 2012

One of the most basic rules for personal financial planning is to establish a personal emergency fund for a rainy day. The conventional wisdom is that the emergency fund should comprise between three and six months’ worth of one’s salary. So for instance, if a person earns $4,000 a month, his emergency fund should be built to at least $12,000.

But increasingly, this conventional wisdom is being challenged on many fronts.

For one thing, financial advisers say that the uncertain economic outlook and higher costs of living mean that three months of savings may simply not be enough.

Mr Patrick Lim, director of financial advisory firm PromiseLand, advises his clients to save between six and 12 months of salary as an emergency fund.

“I see a lot of people who, in their 40s, get retrenched, and they can’t find a job easily. They may take up to a year (to find another job) and even then, they may have to face a pay cut,” he says.

“Call me conservative but I prefer to be safe than sorry.”

Mr Christopher Tan, chief executive of financial advisory firm Providend, agrees and adds that it is not surprising that in the United States, financial experts are saying 10 months of expenses should be set aside as emergency funds.

But whether it is six or 12 months, all financial experts say putting aside a sum of money should be a top priority for everyone.

Financial adviser Leong Sze

Hian says it is absolutely crucial that people focus on building this fund first, even before thinking of buying a house or car.

“They spend and spend, then they lose their job. They end up having to sell off to pay debts or cashing out on their insurance policy before maturity which will cost them a lot more,” he says.

It is unclear whether Singaporeans have adequate savings for such emergencies, but anecdotal evidence from financial advisers points to an alarming lack of awareness.

Mr Lim and Mr Leong say the majority of people they meet do not consciously set aside such funds, either because they think it is not important or they are unaware that they need to.

Says Mr Leong: “It’s not that difficult to achieve and everyone, whether low-income or high-income, should try to do this.”

For the big spenders, here are five tips to get started on building the emergency fund:

Budget, budget, budget. You can’t start saving until you know how much you spend, says Mr Leong.

“Get your family together to sit down and figure out what money comes in and what goes out. Then you will be able to see what can be cut and how to save,” he says.

Set up an automated transfer that channels part of your salary to a savings account.

Says Mr Tan: “Every month, upon getting your net salary, before you even spend your money, stash away your monthly saving amount to another account.

“Continue to do this till you reach your emergency fund. Beyond that, the monthly ‘saveable’ can now be invested.”

Save before you invest. If you have just started working, you should save first before buying a car, says Mr Lim.

“One way to accumulate savings is to look at topping up your Central Provident Fund. For the first $20,000 of your Ordinary Account, you get 3.5 per cent; for the Medisave and Special accounts, you get 5 per cent for the first $40,000,” he says.

“Given the low interest rate environment, that’s a gold mine. Focus on maximising the returns first from these savings.”

Break down your expenditure to the last dollar, including credit card bills. Once you see exactly how much you spend versus how much you bring in, it will be clear how much you need to cut back on, says Mr Tan. Stay clear of debt, including charge and credit cards. If you need to swipe the plastic, make sure you pay it back in full. There is always the temptation to spend more than one has, since one does not quite see the bill until later.
But if you need to use the credit card, pay it back in full. Snowballing on credit card debt is the surest way to destroying any kind of savings.

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