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How To: Manage your Cash? – Part I

by Apoorv Trivedi on
Assets

The Bottom Line

If you’re just getting started on the savings journey, your first priority should be to save about 3 months worth of expenses in your savings account or other transactional account.

Next, you should save cash for medical and other emergency expenses. The exact amount depends on whether you have health insurance and your preference for hospital and ward class.

This amount should also largely be in a savings or a transactional account but if you usually have some credit limits available on your credit cards, you can consider transferring that much from this fund into a cash management account or Singapore Savings Bonds.

The third target for you is to have save around 6 months of expenses for situations like losing your job. While initially this money can be parked in a cash management account or even a savings account, once the amount crosses S$2-3K, you should start investing it in assets with higher expected return e.g. ETFs or diversified portfolios offered by Robo Advisors.


How much cash should I keep?

All of us need to hold cash for our day to day transactions. Apart from physical cash in your wallet, we can consider money in savings accounts, mobile wallets and other similar accounts as cash-like as well. Anything that does not change in value much and is easily accessible.

In other words, cash and  cash-like investments are the safest and most liquid assets you can hold. That also means the return you earn for holding them is quite low.

Once you take inflation into account, the return is typically negative. So it makes sense to minimize the amount and time for which you hold cash.

At the same time, you don’t want to run out of cash because that can be quite costly or inconvenient.

For instance if you run out of cash when you need to pay the rental or credit card bill, you may incur large penalties and hurt your credit score. If you don’t have access to cash in a medical emergency, you may not be able to get proper treatment.

So we need to find the right balance of minimizing the inconvenience and maximizing the return.

Where that balance falls for you will depend on two things:

  1. your financial situation
  2. your convenience quotient i.e. how much hassle you’re willing to put up with to get better returns on your cash.

Ironically, the better your financial situation (i.e. savings & support systems) the less cash (as a % of your assets or expenses) you need to keep.

A high-earning mid-career executive will have much higher limits on their (multiple) credit cards to rely on in a pinch and most emergency expenses will not be very large against their overall resources.

A fresh graduate with a new job but living with her well-off family can always rely on support from them if the need arises.

But if you don’t have those buffers, then you need the insurance of a much higher cash balance.

The convenience quotient is about how frequently you are willing to move money from an investment account to a transaction account and if you usually keep track of your upcoming expenses.

If you can’t be bothered with micro-managing your accounts, you should keep a larger buffer while the rest can run a tighter ship.

There are 4 reasons for which most of us need to keep cash:

  1. For predictable expenses e.g. rent/ mortgage, groceries, clothes, school fees, travel, taxes
  2. For unpredictable expenses e.g. medical emergency, major repair, unemployment etc.
  3. Preparation for a major expense e.g. buying a house / car or for a wedding
  4. Waiting to invest e.g. after sale of house or receiving a bonus

Of these, the first two are always required while other two are more one-off situations that need to dealt with separately.


Cash for Predictable Expenses

The main challenge in planning for these expenses is that many of these are not monthly. Insurance premiums may be annual or semi-annual, many schools charge fees by term and you may take vacations only a once or twice a year.

We estimate that balance of close to 2 months of your income or 3 months of expenses should be sufficient for most people.

Why 3 months of expenses? If you have a regular income and are living within your means, the combination of this balance plus the monthly salary deposit should be sufficient to take care of the larger expenses like insurance premiums and travel.

Even if any large expense reduces this balance below your target, your regular savings should bring it back to target in a couple of months. Our assumptions is that for most people even the larger predictable expenses are in the same ballpark as their monthly expenses.

A person who spends $3,000 a month is unlikely to take a S$10,000 vacation but a person spending S$15,000 a month might do so.

Self-employed people with irregular incomes should have higher balances, based on the pattern of their income but at least 4-6 months of expenses.

Since this amount needs to be available at short notice for transactions, it should be in a transactional account. Usually this is a savings account but some insurers (e.g. Singlife) and wallet providers (e.g. Grab) are also offering transactional accounts with higher interest rates now.


Buffer for Unpredictable Expenses

The challenge here is obvious. These expenses are unpredictable. In timing and amount.

The most common source for these expenses are going to be medical emergencies, repairs (home / car) and, although technically not an expense, job loss.

Of these, its most critical that you are able to handle the medical emergency and the job loss is likely to require the largest buffer.

Medical Emergencies For medical costs, we can use the data from MOH on a costs of various procedures. According to HealthHub, the most common reason for hospitalization in Singapore is accidents.

If we take the cost of treating a broken arm as the benchmark, it ranges from S$3,000 for a subsidized treatment in B2 category ward to S$11,600 for an unsubsidized A category ward in a public hospital. In private hospitals, that may be more than S$15,000.

So depending on your circumstances, the buffer for medical emergencies should be from $3,000 up to S$30,000.

This requirement could be a lot lower if you have a health insurance policy (e.g. from work or an Integrated Shield Plan). In this case, depending on your policy, you may only need to cover the deductible, which usually ranges from S$1,500 to S$6,000.

And you don’t necessarily need to keep the entire medical buffer in a savings account. Instead, if you have typically unused limits on your credit cards, you can invest that amount in a slightly less liquid / higher yielding asset.

Lets say, you calculate that you need a medical emergency fund of S$15,000 based on your requirements.

If you have two credit cards with credit limits of S$5,000 each and you only spend about S$4,000 a month on the two cards, leaving about S$6,000 a month unutilized.

In this case, you still save up a buffer of S$15,000 for medical emergencies, but of that amount, you only keep S$9,000 in your savings account and invest the rest in a low risk investment e.g. Cash Management Accounts provided by Robo Advisors or Singapore Savings Bonds.

If an actual emergency occurs, you can charge the cost to the credit card and redeem the investment. By the time the credit card bill comes due, the redeemed funds will be in your bank account you can use them to pay the card bill.

Rest of the time, you can earn interest on those funds, without compromising your ability to handle the emergency.

Job Search There is no good estimate for how long it takes a person to find a job in Singapore. However, the unemployment rate in Singapore has been below 3% for last many years, so it would seem that finding a job should not take very long.

Still, people’s experience would depend on their industry, experience, seniority etc. and can vary a fair bit. Within 6 months may be a reasonable estimate for most people.

Unlike medical emergencies, the buffer for job loss will not be needed immediately. The money is needed largely to fund you daily expenses while you look for a new job and you also have the flexibility of adjusting your behavior to cut costs.

So 6 months of your regular expenses should last you for a bit longer in this case.

However we don’t think this amount should be kept in savings account or even in low risk assets like cash management accounts or Singapore Savings Bonds.

In case of a job loss, your entire liquid net worth is available to tide you over till you get a new job. If your liquid net worth is less than 6 months of expenses, you should definitely save aggressively till you cross that limit.

But otherwise these funds should be invested in line with your target asset allocation, in stocks, bonds and other investments.

There is an argument that you are more likely to lose your job in a weak economy. That is exactly when the stock market is likely to down. So if your emergency fund is invested in the stock market, you will be forced to sell it at a bad time.

We disagree. Most people will lose their job once in 5-10 years, if at all. And you don’t know when that will be.

The expected return from your regular investments in positive. It does not make sense to give up 5-10 years of positive expected return in order to protect against a low risk event.

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