lesson #3: keep a financial raincoat for the rainy days

with the Philippine stock market correcting sharply in the last few weeks, a couple of acquaintances dropped me a note asking if it is a good time to start investing in equities.  they heard or read somewhere that it is a good entry to bargain hunt for stocks when the market is in a corrective phase.  i, for one, am excited at the moment that the market is oversold (though the MACD has yet to resolve itself) since i could add positions to my current portfolio at a lesser cost.  


for first time investors, however, the bigger question is not whether right now is a good time to enter the stock market. the more important issue to address is whether you are properly covered financially when the usual monetary inconveniences hits the fan.


why is this so? investing in the stock market is a long term activity. when you invest in stocks, you acknowledged and respect the law of the farm. the law of the farm recognizes the natural laws and principles that govern the work and determine the harvest. a sugarcane plantation requires certain investments in money and time for the harvest to be bountiful. doubling the money you put into a sugarcane plantation does not make the harvest season to arrive earlier.  put it another way, having all the time to wait for the harvest without putting enough investment on the farm does not guarantee you will generate quality crop. investing in stocks require you to allow time to grow your money (assuming you have picked stocks of solid, profitable companies).


when one invests in equities, one should do so using funds they can afford to not need for a couple of years.  and the only way for this to be possible is to ensure that you are covered financially when shit happen.  and this is one of the major role of an emergency fund. an emergency fund allow you to address unplanned event in your life without you having to sacrifice your investments.  emergency funds can pay those hospital bills, or fix your broken car, or that Hong Kong disneyland trip you promised (and did not fund for) to your kid if they end up at the top of their class.


you need to set up an emergency fund even before you venture into high risk, high return financial investment vehicles.  this will keep you from having to prematurely liquidate your investments because you do not have enough cash to cover for emergencies.


when is an emergency fund considered enough?


financial experts have different opinion on how much emergency fund is considered enough.  the number varies from three months to one year’s worth of expenses. personally, i built three month’s worth of emergency fund before i ventured into investing.  and then, i continuously added funds to my emergency fund alongside investing with a goal of having one year’s worth of emergency fund. as of this writing, i am covered for eight month’s worth of my expenses. hopefully, i never have to drain it out for emergencies.


what should be covered in an emergency fund?


i answered this question by looking at my monthly and annual commitments. when i started, i only covered for the basic necessities like rent, utilities, meals, transportation and the monthly allowance for my siblings whom i was (and am) currently sending to school (if you have family, your children’s basic needs should definitely be added in the list).  after building three month’s worth of fund for these, i started considering annual commitments like premiums for my life, car and health insurance. i have also started covering tuition fees for my dependents. when i get to six month’s worth of that, i added another budget for my splurge fund, having developed quite a habit of buying promo airfare tickets to just anywhere else in the world.


the first step is always the most challenging.


the difficult thing about building an emergency fund is insisting discipline on it.  Filipinos are naturally optimistic people and that optimism provides us a brighter outlook on everything.  on the bad side, it also makes us a bit lax when it comes to instilling commitment on building a fund for bad things that may or may not happen.  when things are smooth sailing, it is kind of hard to imagine things going suddenly wrong.


on another hand, when we are living from paycheck to paycheck, the excuse has become centered on the fact that we barely could meet our day to day needs that it is almost close to impossible to set aside money for a future emergency.  the irony of this argument though is the fact that we only need to look back to the history of our payslip and we can easily see that our lifestyle is changing upwards faster than our salary could catch up with it.  the problem is not about not having enough money to set aside for emergency funds; the problem is that we are spending at a faster rate than we are earning the money to fund for it.


the key to battling with these misconceptions is to get one’s self into a force savings routine.  in an investment program i have introduced in the company i worked for, employees have the option to enroll in an auto-debit investment program where every payroll, a pre-defined amount is deducted from their payroll and the company remitted the same to the investment vehicle of their choice.  a number of my rank and file employees put in between 5-10% of their pay into the program.  strangely for them, they found absolutely no degradation on their current lifestyle.  they could barely feel the reduction; quite automatically, their spending habits accommodated the lesser money.  


a number of companies offer an employee savings program (the luckier employees get to enjoy an employer match).  if you work for a company that has this, take advantage of that.  it will simplify the need to develop discipline to save for emergency funds.  if you do not have this option, activate an auto-transfer from your payroll account to another savings account you have no ATM access of. 


be smart where you maintain your emergency fund


having three months to twelve months worth of emergency fund is a lot of money.  and because you set it aside for something that may or may not happen, it pays to know where to park it.


after a couple of years of trial and error, i have found out a way that maximized the value of my emergency fund and at the same time provides me confidence of its capital preservation.


1. leave one month’s of your emergency fund in a regular savings account.  leaving it in a regular savings accounts allow you to withdraw it without fees or penalties when you need it. on the bad side, a savings account does not protect you from inflation loss.

2. put about three months’ worth of emergency fund into a money market fund.   money market funds are not guaranteed by PDIC but is a very highly liquid investment vehicle.  it also has a very short lock in period- about three days for most financial institutions offering it. there is no guarantee of capital preservation for this product but due to the nature of the fund, it is highly possible to keep the value of your investment and enjoy a bit higher return on your money than keeping it in a regular savings account or a time deposit account.


if you have more than four month’s worth of emergency fund, it would be worth considering putting the money in excess of four months into financial vehicles that provides an opportunity for higher returns in exchange of a bit of investment risks.  in my case, i invested the balance in retail treasury bonds.  retail treasury bonds are issued by the Philippine government and pays the holder quarterly interest.  i got access to the earlier issued bonds and currently enjoying 5-8% interest on those, materially higher than the more recently issued bonds.  partly because of that, the bonds i currently have are trading between 120% to 150% of their face amount (i got them at 99% to 101%).  


retail treasury bonds require higher minimum amounts to invest though (minimum investment is Php200,000 per treasury bond). alternatively, a bond fund could provide you the same (or even higher) rate of return without investing a huge amount everytime.  bond fund allows investor to participate on certain bonds the asset carries that is otherwise inaccessible to buy directly.  the value of your investment fluctuates daily though as it is also exposed to the daily fluctuations of the bond’s market value.  i will be discussing retail treasury bonds and bond fund in more detail in my future posts.


going back to my acquaintances’ inquiry on the timing of putting in equity investments, i asked each of them about the current state of their financial affairs. true enough to my hunch, most of them do not have an emergency fund set up.   they were more excited about the prospect of starting to fund their retirement years it did not occur to them that having an emergency fund actually could complement that.


it is understandable that people get are more inclined to spend money in the present than building an egg nest for retirement.  it is even more understandable that people get more excited building a retirement fund than saving for rainy days.  but as certain as you will reach your golden age is the possibility of a financial windfall. someone gets sick. cars break down. we lose our jobs.


it pays to pay attention to that.   


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