One Lesson – To Increase Your Personal Finance Awareness
So far we have discussed what is personal finance and its components. We discussed briefly about emergency funds last week. I wrote –
“Setting up an emergency fund – This should be the first item in your financial plan. This is a fund set up to help you in case of extreme emergencies. Like a loss of job or a big medical expense. One must always keep in mind that this fund is for emergencies only. And like Dave Ramsey said “Christmas is not an emergency”. It is recommended to have three to six months of expenses as an emergency fund. But I am a very conservative guy and I like to double up. My recommended emergency fund size is 12 months of expenses. “
By definition we know that this fund is set up to meet emergencies and usual recommended size is 6 to 12 months of expenses. One expert investor on Twitter recommended an emergency fund of 24 months.
Where should you really invest this money?
Largely in safe liquid instruments. You could park the money in a bank account, term deposits, or a liquid fund which invests in very short term government securities. You could stash this money under your mattress too. There is no hard and fast rule. The only rule is easy accessibility.
Now that we have figured the text book concept of emergency fund, let’s do a deep dive to see how should it work in different circumstances. Firstly, the text book rule is not applicable to everyone. It really depends on the situation of each individual. Let’s take a few cases and see how should it be treated.
1. A person has a net-worth of 3 million dollars in equities and monthly expenses of 10 thousand dollars. I don’t think this guy needs an emergency fund. If he ever has any kind of emergency, he can redeem his investments. The corpus is big enough to take care of any emergency. It shouldn’t bother him even if his equity portfolio falls by half. The amount required to set up an emergency fund is pennies to his net worth.
2. A person has a net-worth of a hundred thousand and monthly expense of 3,000 dollars. His net-worth is split between equity and debt instruments in the ratio of 60:40. He doesn’t need an emergency fund too. Since this guy has investments in safer instruments, all he must do is make sure that some part of it is in the most liquid instruments.
3. This guy has a negative net worth. He has more borrowings than savings. This one definitely needs to have an emergency fund. It is a possibility that this guy might not be able to borrow further during an emergency. He should set aside a fund and use it in extreme emergencies only. Remember the quote from Dave Ramsey.
For anyone who is starting his job with zero savings and zero liabilities, it is highly recommended to focus on setting up an emergency fund. Save a big chunk of your salary for the first few months in a liquid fund and you are sorted for life.
How else could you create emergency funding lines?
Credit cards – One of the great ways to access emergency money. However its not suitable for someone starting his financial journey. You definitely need a higher net-worth to be having access to a credit card with higher limits.
The initial credit limits provided are quite small. Not enough to cover your emergency requirements. The more time you spend with a credit card company, your credit limit keeps going higher. I have some credit cards where my credit limit is 10x the initial limits. You must make sure that you have capacity to pay the bill if you use the card for larger emergency expenses. Avoid credit cards in case of a job loss. Would be a foolish thing to do.
2. Overdraft facility – If someone does not want to dip into his investments/ savings at all, this is a great facility. All you have to do is pledge your investments against this facility. Interest will be charged on the amount drawn and can be repaid anytime. You need the discipline to avoid withdrawing regularly. If you think you’ll not respect the objective of having this facility, please avoid.
One Idea – To Change The Way You Think About Money
“Avoid buying a house in early 20’s”
Borrowing is negative Compounding. Your money works against you. Avoid buying a house on borrowed money in your early 20’s. You have a lower salary and a very high EMI. Interest accrues on interest and you end up with a multi-decade liability. Focus on increasing your income instead. Time is your friend in 20’s. Compounding needs time. If you really want to create wealth in your life, avoid having big liabilities early on in your carrier. Making compounding your friend. Not your enemy.
One Hack – To Add More Money To Your Bank
We all have expenses. Why not spend wisely to get some returns. Credit cards are a great way to do that. There are plenty of cards which give you a return on your spending. I use cards where the net returns vary from 5% to 30%. You need to be wise. What card you get depends on your earnings and credit scores.
American Express Membership rewards card is one such card which returns almost 20% on annual spends of 50,000 bucks. You can use my referral link to sign up. You will receive an additional 2000 points. Send me an email if you want to learn and discuss more about this card or any other card for that matter. Even better, goto cardexpert.in and livefromalounge.com . If you reside in US, checkout pointsguy.
One Compounding Story – To Convince You About the Power of Compounding
Sylvia Bloom was a secret millionaire who lived modestly and took the subway to work at a Street law firm where she was a secretary.
Responsible for managing her boss’s stock investments, she carefully observed his decisions and mirrored them with smaller investments of her own.
Bloom continued working for the same law firm for 67 years, and passed away shortly afterward in 2016. Over time, she built a fortune that was spread among 3 brokerage houses and 11 banks.
Bloom was frugal but not cheap. When Sylvia passed away in 2016, she was worth 9 million dollars and left $8.2 million to charity.
Upon her passing, even her closest friends and family were shocked to learn of Bloom’s fortune. Ms. Bloom spent a lifetime reinvesting dividends instead of spending the profits from her investments. Sylvia and her husband, a firefighter, could easily have been living on Park Avenue, but instead chose to stay in a rent-controlled apartment.
Key Takeaways –
1. It is alright to clone. Mohnish Pabrai claims himself to be a big cloner. He has also written a book called the Dhando Investor. Its a good read.
2. Be Frugal. But like Ramit Sethi says ‘spend extravagantly on things you love’.
3. Wealth creation happens with a long term horizon only. Understand how compounding works. Practise it. Money and good habits compound over long term. The results can be dramatic.
4. Equity is the only route to create wealth without any specific knowledge. All you need is a simple instrument like an index fund. Deep work is required to create wealth in real estate, art or other alternative assets. Just keep buying and stay invested.
Thanks for reading!
If you learnt something, please forward it to your friends and ask them to subscribe. If you are unsubscribing, please please please give me a feedback.
Recent Blog Posts