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.
This is especially true when inflation numbers are rising like they have been recently – the higher the inflation rate is, the more quickly it eats away at the purchasing power of our cash over time.
Here, we’re sharing just how much cash you should have (and where you should put it).
Your current account should have 1 to 2 months' worth of expenses. Any more than that, and you're losing your cash's value to inflation.
Your emergency fund should have about 6 months' worth of expenses. We recommend keeping it in a low-risk, liquid investment, such as our cash management portfolio.
For upcoming expenses, such as a wedding or a house deposit, consider keeping your funds in short-term investments.
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, the more you're 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 sooner.
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 keeps up with inflation, make sure it's not in a savings account. Instead, you want your emergency fund in a liquid, interest-earning account.
This can be a:
Money market fund
Any other low-risk, liquid investment
Here's what you need to know when evaluating the options for your emergency fund:
Many banks advertise an attractive rate on their savings accounts. But the reality is that only a portion of your balance is actually eligible for this advertised rate, and often only eligible for a specified period of time.
For example, if your emergency fund of RM100,000 is in your savings account, it's most likely that that entire RM100,000 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 RM100,000. Maybe you're earning 3.8% on RM15,000, and then a lower interest rate on the rest. Ouch. Make sure you read the fine print.
Fixed deposit accounts often charge 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.
The key to having an effective emergency fund?
Make sure it doesn't wither in a savings account.
Have just enough in your fund so that you'll never have to dip into your medium- to long-term investments in an emergency. Doing this could compromise your long-term financial goals. That's why we say your emergency fund should cover at least 6 months’ worth of expenses.
Make sure that it's low risk - you never want to expose your fund to unnecessary volatility that could risk your cash just when you need it.
StashAway Simple™ is our ultra-low risk cash management portfolio that lets you earn competitive returns on your cash. It has a projected 2.5% p.a. return on any amount (seriously, any balance has that projected return), with none of the hassle of investment requirements, credit cards, tiered earning structures, and whatever else the banks have come up with to make it painful to manage your cash. You can withdraw any amount of your funds at any time without penalties.
Putting a downpayment on a house soon? Paying for your wedding? 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. But that doesn't mean that you should 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 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 annualised returns of 1.7% (as of April 2022).
We can’t emphasise the importance of liquidity enough; make sure that whatever vehicle you select, 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're talking about your medium- to long-term goals that need to take advantage of compound interest 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.