Have you ever been to the circus and watched aerial artistes go through their motions on a high wire act?
If so, you should also have noticed, at least in passing, that the safety net strung out directly below the acrobats serves a rather important function.
To succeed in our financial lives, we too need a ‘safety net’. In my Malaysia-based financial planning practice, I insist that each carefully selected client puts in place a reserve fund of between 3 and 12 months’ expenses.
I call this reserve fund an emergency buffer account. Its purpose is to provide fiscal and emotional stability during times of economic upheaval.
You see, for most of us normal people, our biggest asset is not anything that shows up in a conventional net worth statement.
A net worth statement is nothing more than a simple listing of material assets and liabilities, which allows for quick calculation of your net worth position. (It’s quick because your net worth is mathematically derived by this simple formula:
NET WORTH = ASSETS minus LIABILITIES
Typical items that show up on the plus side of a net worth statement are key assets like cash, stocks, mutual funds or unit trusts, vehicles, gold, real estate and jewellery. Normal liability line items are home mortgages, credit card balances, car loans and family loans.
All these are important, but the biggest asset a person has is not one of the key assets I mentioned. The biggest asset for most of us is our capacity to earn money for 20, 30 or 40 years at our jobs.
Yet, let’s face it, most of the money most of us will ever earn quickly evaporates as personal expenses, interest charges or taxes.
Clearly, to be successful financially, we have to reduce that seemingly persistent rate of evaporation. Let me be blunt:
Our long-term future wealth can only be built from the
bricks and mortar of the financial surplus we set aside each month.
This surplus should usually be invested in assets that fluctuate in value. It has been historically proven through more than 200 years of equity market data that those who are most able to ride the ups and downs of markets are the ones who tend to accumulate the most wealth.
But to be able to ride those nerve-wracking but eventually profitable fluctuations, you must have a safety net whose strong strands are made of cold hard cash. This safety net is your emergency buffer account.
However, if you’re concerned that you don’t know enough about investing to risk putting down real money in real investment markets, then what you need as much as an emergency buffer account is an education programme.
My FREE e-book 26 Books to Take YOU All the Way to the TOP! is an ideal resource to help you begin a five-year self-study programme in personal finance, economics and investing.
You are welcome to download this e-book at the main page of http://www.rajendevadason.com. Just scroll down to the E-bookstore section, click on its icon, and follow the download instructions.
Now, as I was saying about the ups and downs of markets, you will find that fluctuations in investment asset values usually go hand in hand with the dips and rises of the general economy.
The perverse side of Nature that has caused Murphy’s Law (‘if anything can go wrong, it will’) to gain such wide prominence is that in most cases when you need extra cash because of a downturn in your personal, internal economy, the entire external economy also chooses that moment to falter.
The only way to safely ride the bumps in our economies - general and specific - is to have our financial safety net in place.
So, look at your own circumstances, check your various bank balances, other savings and investment balances and figure out just how long you can last if a catastrophe takes place today that stops you from actively earning a living for one full year.
Be honest now, can you last a week, a month, three months, six months, nine months, or a year?
Only you can answer that question.
I hope you do just that because the answer you give the person you see in the mirror will help you confront honestly where you are in your life’s financial journey.
Again, your willingness to invest resources in educating yourself is directly correlated to your chances of long-term success in the financial arena. If you see yourself as a rookie in this field, then my very first book, Your A-Z Guide to the Stock Market – And all You Need to Know About Capital Terms, is a great resource. It contains 1,001 terms that are usefully cross-linked to help you take a self-directed journey of financial self-education. (If you would like to order a copy, do drop my associate Steven Poh an email at firstname.lastname@example.org).
PRACTICAL STEPS YOU CAN TAKE!
Now, here are my guidelines on emergency buffer establishment for your consideration:
If you are employed by an established, healthy company that is unlikely to go bust anytime soon, put in place savings amounting to between three and six months’ normal expenses. If your boss loves you to bits and can’t get along without you, three months is plenty. But if your boss would love nothing better than to tear you to bits and spit out the pieces, err on the high side!
If you are self-employed, running your own business, make sure you have at least six months’ expenses available in savings if your business is in good shape with many clients who pay on time. If business is shaky, then opt for an increased buffer size. Having a full year’s reserves is generally more than enough for most people.
Warning: It may take as long as three years to build this
buffer. So, keep at it and save diligently.
And remember, your emergency buffer is for emergencies, not for exciting ‘opportunities’ like a great sale at the local department store! Having your buffer will give you financial stability.
This stability will help you weather the ups and downs of the investment markets.
Just one point before I conclude: If you currently have very little saved as a buffer, you are in a financially precarious position.
It is imperative that you reduce your near-term expenses and build up your reserves as fast as you can to your targeted sum.
For most people, doing so usually takes anything from 12 to 36 months. It’ll be a long slog, unless you suddenly have a massive bonus land on your lap or have an investment go ballistic.
Do yourself a favour. Don’t bank on or hope for some strange occurrence to provide you with the funds needed to weave that safety net. Just do the work and set the money aside in a safe place where yields may be low but certainty of return is high.