Building an Emergency Fund

How much should I save? As a rule of thumb, a saving ratio of 20% is considered healthy. Saving ratio is defined as total annual saving divide by total annual income.

As you start saving, your first priority is to build up your emergency fund. Establishing an emergency saving account is vital in both good and bad times. It is an absolute necessity for financial security because it gives you funds to fall back on if you or your spouse lose your job, incur large medical bills, unable to work for certain reasons, and so on. Without an emergency fund, you may be forced into incurring credit card debts that could take you many years to pay off. You don't want to be living on the edge, do you?

To build up your emergency fund, you have to put away the money consistently on a regular basis. As it grows, be sure not to dig into it for non-emergencies purpose. Remember, this fund can only be tapped for true emergencies.

How much do you need in this emergency fund? The minimum amount to have should be at least 3 to 6 months of your basic living expense. It has to be sufficient to tie you over during the period when your income stream is suddenly cut off. So examine carefully your income and needs to decide how much you actually should save. The level has to be comfortable to you.

Where should you be keeping your emergency fund? Emergency fund must be easily and quickly available and accessible when needed. It is best kept in liquid assets. Liquid assets refer to assets that can be converted into cash quickly. Example of such assets include saving account, time deposit, money market funds, and short term bonds. Do not put your emergency fund in property and stocks/shares. Property is not a liquid asset because it takes months to sell it. Stocks/shares are somewhat more liquid than real estate, however you can lose money if you are forced to sell it at the time when the market for your stock/share is less favorable.

The Power of Compounding

I cannot stress much more the importance of saving if you want to create wealth for yourself. Save and Invest is one good wealth creation strategy that you can easily adopt. The reason you save is so that you can let the money work harder for you. As a start, you work hard for money. But up to a stage when you have accumulated some saving, you have to let the money work for you.

Allow me to show you how saving can work wonders for you. Let me introduce to you the concept called the "Power of Compounding Interest". This comes about because over a long period of time, you will actually experience your money feeding on itself, earning you additional dollar that will accumulate into sizable amount.

Through investing, you can actually double your money over a period of time. How long that is will depend on your rate of return.

If your rate of return is 2%, then it takes 36 years to double your money. Whereas if your rate of return is 7%, it doubles every 10 years.

To illustrate, let's say you have an initial investment of $100k.
If this is invested at a return rate of 2%, in 36 years, your money would have reached $204k.
If this is invested at a return rate of 7%, it will double every 10 years and in 36 years time, your money would have reached $1.1 million.
Which one do you prefer?

So the lesson learnt today is: Do not just leave your money in the bank. You will be missing a lot if you do. Let your money work harder for you.

For those interested to know When? you will double your money with a given rate of return, use this formula. Take 72 and divide it by rate of return (without the %). For example, if I divide 72 by 2, I get 36. This means when you invest your money at a return rate of 2%, it takes 36 years to double your money. Similarly, if your rate of return is 5%, then it takes (72/5) 14.4 years to double your money.

In addition, if you want to prove that it really takes 36 years to double your money for a given rate of 2%, use the future value (FV) formula in Microsoft Excel.

I hope you have learnt something today.

Why is it Important to Start Saving Early?

A fews days ago , I mentioned that it is important to start saving as early as possible. I would now like to illustrate this in terms of the table given below.

Assume that a person saves $500 per month and assume that his desired age of financial independence is 55. How much funds do you think this person would have accumulated when he reaches 55.

See this:

Starting ------------------------ return per year ----------------------
Age 2% 5% 7% 10% 15%

30 $196,025 $300,681 $406,059 $649,091 $1,468,272
35 $148,700 $208,316 $263,191 $378,015 $ 706,861
40 $105,836 $135,945 $161,328 $209,698 $ 328,305
45 $ 67,012 $ 79,241 $ 88,702 $105,187 $ 140,096
50 $ 31,849 $ 34,811 $ 36,920 $ 40,294 $ 46,522
55 $ 0 $ 0 $ 0 $ 0 $ 0


What does the above table tell us?

1. There is cost for waiting. A person aged 30 who save $500 and invest at a rate of 7% will reap $406,059 when he reaches 55 whereas a person aged 40 will reap only $161,328. That is 3 times less than the person who starts early.
2. The longer you delay, the more pain you give yourself. In order for the person aged 40 to achieve the same amount of funds, as the person aged 30, when he reaches age 55, he will have to save much more every month. How much? $1,274 every month (assuming a return of 7%).
3. How much funds you are able to accumulate shall depend on WHEN you start and the investment returns you get. If you just leave your saving money earning 2% and do not make your money work harder for you, you are not going to get far in reaching your retirement funds either.
4. It is possible for a person to achieve financial independence just by saving and investing over a sufficient period of time.

For those who are already late in adopting this strategy, do not worry. It is still not too late to start saving now. However in order to achieve your financial independence, you will need to look at other wealth creation strategies as well.

The Power of Saving

Let's recap before I begin with today's topic.

To start your wealth creation journey, it is important that you begin it with an end in mind. With your dream or desire translated into financial goals, your direction becomes clear and your actions become obvious. Click on "begin with an end in mind" if you need help in formulating your financial goal.

Once your goal is set, the next step would be to manage your spending. It is obvious that income you earn either goes to spending or saving. In your wealth creation journey, it is critical that most of your income goes into the saving bucket. Click on spend below your means and more managing spending tips to read more about how to manage your spending..

Believe it or not, Saving can do wonders to your wealth creation journey. Why? This is because it is a cash generating asset and its potential can be huge if you make it work for you.

At this point, I would like to introduce to you two concepts - the power of time and the power of compounding.

Here is one thought from the Richest Man in Babylon

Wealth, like a tree, grows from a tiny seed. The first copper you save is the seed from which your tree of wealth shall grow. The sooner you plant that seed, the sooner shall the tree grow. And the more faithfully you nourish and water that tree with consistent savings, the sooner may you bask in contentment beneath its shade.

Basically, he is talking about the power of time. If you save a little for a long period of time, it will grow and grow and grow and you will be able to grow your wealth tremendously.

He also talked about the power of compounding, where over a long period of time your money will actually feed on itself, earning you additional dollars which ultimately grow into a sizable amount.

So what is the lesson learned? Start early, start now. Save/invest as much as you can and keep doing this over a long period of time and you will accumulate a substantial retirement fund in no time.

Stay tuned. I will illustrate the two concepts with figures when I come back. I am sure it will be an eye opener to you. But do not be shocked, ok?

See you!. Visit my website too if you have some time. http://www.wealthcumhealth.com/

More Managing Spending Tips

Welcome back! Today I would like to continue where I left off last week. See below post if you have missed it.

Last week, I mentioned that the first step to creating your wealth is to manage your spending. Mortgage debt is one area that we must carefully handle to ensure that we do not commit too much and for too long a period. Why? and How? See post below.

I am sure you know as well as I do that if your income is not spent away, it would be saved. Which one of the following is your habit of managing your income?

1. Earn and spend all that you have earned;
2. Earn, spend and then save the balance, but subsequently spent it away on big ticket items or doing nothing to grow the money;
3. Earn, save and invest on cash generating asset, and then spend.

Which habit do you think will generate you more wealth over time? The answer is obvious, isn't it?

Hence, another way to manage your spending is to PAY YOURSELF FIRST. And you pay yourself first because you have a reason for doing that. How much you need to set aside will of course depend on your financial goals. Refer to below post on "begin with your end in mind" to identify your goals and determine how much saving you would require to achieve your financial independence.

Now, let's ponder for a while about your buying habits. Has it happen to you before that you bought something and later realized that you actually do not require them? Very often, isn't it? Yes, and this is called impulse buying. To manage your spending, this habit has to change. You need to ask yourself whether do you really need this. You have to differentiate between needs and wants. Spending on the latter is not a necessity and should be avoided or postponed till you truly have excess cash at your disposal

Good, I hope you have learned some useful tips on managing your spending. Remember that each dollar spent will cost you in terms of opportunity cost in the future. Stay tuned to find out more!

Spend Below Your Means

Have you got your financial plan? If no, you may want to refer to earlier post to read about it. If yes, you are now ready to take action.

What do you think is the first step? Many people would think that by increasing their income, their wealth will automatically increase. Unfortunately, increasing income is only one side of the wealth equation. There are people who earn $2,000 a month and are broke and there are those who earn $20,000 and are still broke. The reason is simple. When we don't manage the money we earn, our expenses will always rise to our level of income, wiping out any surplus we have. Or worse, we start to spend on credit lured by easy repayment schemes.

Henceforth, managing your spending is one contributing factor to increasing your wealth. The number one trait that you must possess is to be FRUGAL and live well BELOW your means. Once spending is reduced, your saving will increase and correspondingly your wealth will increase too.

In that case, how am I going to own a house and buy a car? Well, taking a consumer debt would be unavoidable. However, you must avoid taking on too much for too long a period.

Use the following ratios to measure if you have taken too much debt.

• Total Debt / Total Asset Ratio. This measures one's ability to pay one's debt. It should not be more than 50%
• Mortgage Debt / Total Annual Income Ratio. This measures one's solvency and ability to pay one's debt. Advisable limit is 5 times for those below age 30; 3 to 4 times for those age 30 to 40; 2 to 3 times for those age 40 to 50; 1 time for those age above 50.
• Debt Service Ratio. i.e. total debt repayment / total annual take home income. This measures how much income is needed to repay your debt. A ratio of > 50% is considered excessive. A ratio of <>

In addition, you must avoid taking on a debt for too long a period. In other words, you must reduce your debt as soon as possible. Why? This is because a 5% -6% interest rate, which may seem small, can compound to a huge amount of money over an extended period of time. You will find yourself paying thousands of dollars in instalment payments every month just to see that the principal sum you owe go down by only a couple of hundred dollars.

For example, let's say you bought a $500k Apartment and took a $400k mortgage at 6% stretched over 30 years. If you just pay the minimum instalment payment (using PMT formula in Excel, it is $2,386.27) every month, how much do you think you would pay for in interest eventually? The answer is $459k ($2,386.27*360 - $400k) in interest to the bank. That is like buying two apartments and giving one to the bank!.

That is all for now!. Be sure to look out for more tips.

Begin with an End in Mind

Are you living on a paycheck to paycheck every month? Ever wonder what will happen if the next paycheck doesn't arrive the next month? Well, I leave that to your imagination. I think you know it better yourself the kind of situation you will be putting yourself in.

All of us are busy everyday working hard to earn a living. The question is: Do you want to do that every single day of your life? Seriously, do you want to? Even if you don't mind, do you think you can work till the last day of your life? I guess that would not be possible either.

For many, even if you are not living on a paycheck to paycheck, I am sure, if given a choice, you do not want to just earn a living, you want to live a LIFE. And I am telling you that this is possible if you set your mind to it.

Whether it is for retirement or to improve our life, I think it is important that we seriously look into our personal finances. Today, I would like to talk about Financial Plan.

To be successful, a corporation has a business plan. Similarly, a person ought to have a financial plan in order to be successful in life, isn't it? With a plan, your direction is clearly set out and the actions you need is clearly spelt out.

How do I develop my financial plan? Just follow these simple steps:

1. Determine the amt you need annually to enable you to live the lifestyle you desire without having to work. Please be realistic with yourself when you do this. Otherwise you will fall off the chair later when you see the derived financial goals.
2. Divide (1) above by the rate of return. The rate of return shall be the return you expect to earn from any investment. Usually a very conservative rate is used as you would not want to put the funds in high risk investment.
   
3. The resulting amt shall be your financial goal.
4. Next, tabulate out how much assets you have right now. By assets, I mean bank deposits, CPF money, Life insurance/Annuity, unit trust investment, stock investment, investment property, etc. i.e. cash or in kind that generates cashflow for you. At the same time, assign an assumed ROI (return on investment) for each class of assets tabulated. Thereafter, work out the weighted ROI for these total asset currently held by you.
   
5. Prepare your income and expenditure statement to determine your annual saving. In the same manner as mentioned in 4) above, tabulate out to which assets the annual saving is channeled and then work out the weighted ROI.
6. With the given weighted ROI from 4) and 5) above and assuming that your annual saving continues to accumulate and your total assets continues to grow at the given ROI, determine how much your wealth would have grown by the time you retire. Use the future value formula in excel file to get this number.
7. Compare the total wealth that would be accumulated in 6) above to the financial goals derived in 3) above. Do you have a financial gap?
8. If there is no gap, good for you. It just means that you do not have to do anything differently from now and if things go smoothly, you will reach your goals by the time you stop work. If there is a gap, you have to review your investment portfolio and/or the amount of the annual saving. This can be done by first determining the ROI you need to have to close the gap. Using the future value formula, make a few reiteration by changing the ROI until the gap is closed. You may have to adjust your annual saving too to finally come to a comfortable ROI and annual saving that will help you achieve your financial goals. (Caution: for some, you may have to also look at multiple source of income to boost your wealth creation)
   
9. Once the desired ROI and annual saving are defined, you are ready to take action.

Isn't that simple? Don't you find that you have a clearer picture in your mind now where you need to go and what actions you need to take?

If you think you need more help in this area, feel free to get hold of a copy of the free financial plan template that is available to you at the top right hand corner of the blog.

Wishing your success!