Head of Partnerships
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Managing your cash effectively is the key to a successful long-term financial plan. When we say “managing your cash effectively”, we’re saying that you should have just enough cash in just the right places. In another article we explain why having too much cash is a bad thing. Here, we’re getting into how much is just right.
Current accounts earn negligible interest, so anything more than what you’re spending in the short term is actually decreasing in value because of inflation. So, to protect the value of your money, you should only use your current account to hold enough cash to cover your monthly expenses for the next 1 to 2 months.
To make sure you have enough for that 1 to 2 months, plan ahead by looking at your bills (rent, utilities, phone, taxes, mortgage), and any purchases you anticipate (from meals to a vacation you’re taking this month, for example). You don’t need more than what you’ve budgeted for the month in your current account. If that small amount makes you nervous, go ahead and add a little buffer, but keep in mind that the bigger the buffer, you may be more likely to overspend. The size of your buffer comes down to how disciplined you can be versus how risk averse you are.
In short, the only money that shouldn’t be put to work is what you’re allocating yourself to spend that month, which should be in your current account so you can easily withdraw. Any money you're not spending in the next 1 to 2 months can be put to much better use in an interest-accruing account or investment product so that you can reach your financial goals.
Because you (hopefully) don’t need to tap into your emergency fund often, there’s likely a good chunk of time in which this money can grow so that it doesn't lose its value to inflation. To make sure your emergency fund's value at least keeps up with inflation, make sure it's not in a current account. Instead, you want your emergency fund in a liquid, interest-earning account. This can be a savings account, money market fund, or a low-risk, liquid investment.
When deciding where to keep your emergency fund, use discerning judgment when you’re evaluating interest rates. Many banks advertise an attractive rate, but the reality is that only a portion of your balance is actually eligible for this advertised rate, and often only is eligible for a specified period of time. For example, if your emergency fund of $100,000 SGD is in your savings account, it's most likely that that entire $100,000 SGD isn't earning the rate; instead, it's likely earning a tiered earnings rate, meaning you tack on small interest increments with each dollar you have, up to a certain balance threshold. So, if the bank is offering a return of, say, 3.8%, you most likely aren’t earning 3.8% on the full $100,000 SGD— maybe you're earning 3.8% on $15,000 SGD of it, and then a lower interest rate on the rest. Ouch. Make sure to always pay attention to the fine print.
Fixed deposit accounts aren’t good options for your emergency fund because you’d have to pay a penalty for withdrawing your money before it reaches maturity. The key with the emergency fund is to have liquidity that you can access whenever life throws you a curveball.
You can also keep your emergency fund in a low-risk investment, as long as it’s liquid. Other than making sure you don’t let your emergency fund wither in a current account, you should make sure that you have enough in your emergency fund to not need to touch your medium to long-term investments in the event of an emergency. That would likely compromise your long-term financial goals.
When it comes to how much you should have in your emergency fund, we say that your emergency fund should cover at least 6 months’ worth of expenses.
Putting a downpayment on a house soon? Paying for your wedding? Although the last thing you’d want before getting ready to make those exciting payments is for the money to drop in value because of a dip in the market, you also shouldn’t keep this money in cash.
Instead of keeping these funds in cash, we recommend that your short-term investments (0 to 3 years out) are in low-risk products that earn a return (e.g. don’t put your downpayment in a current account until you’re about to transfer it, and don’t keep it in a risky portfolio, either). Liquidity and low volatility are critical when it comes to short-term investments.
Our goal-based investments manage your risk as you reach the timeframe you indicated so that as you get closer to your goal, your potential downside decreases so that you have the money you need to make that purchase. While we manage your risk exposure, our investment framework also seeks to maximise your returns. The result is that you earn comparable returns at a fraction of the risk that you’d have to take elsewhere: Since 2017, our lowest-risk Investment Portfolio has earned about 9.85%.
We can’t emphasise the importance of liquidity enough; make sure that whatever vehicle you select that you can easily access your money when you need it. That’s why we don’t have any lock-up periods, and you can withdraw at any time for free.
The rest of your money needs to be working for you even harder. We are talking about your medium to long-term goals here that need to take advantage of compound interest in order to reach them. If you have any of those funds in cash, you’re missing out on potential returns that could help you reach those goals sooner, as well as give you more flexibility to do more with them. If there’s money that you don’t plan to use in the next few years and isn’t part of your emergency fund, it should be invested.