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.

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.