One aspect of financial planning that is often neglected is cash management. If you don’t take the time to assess whether you’re keeping the right amount of cash in the right places, you might actually be putting yourself at a disadvantage when it comes to growing your savings.
In this article, we will detail how you can allocate your cash properly to maximise your ability to earn more from your savings.
How much should be in your current account
Your current account should hold just enough cash to cover your expenses for the next 2 months. Anything beyond that amount is exposed to inflation and you risk losing value on that idle cash as current accounts earn very little interest (if any at all).
Plan and set aside the amount you’ll need for your expenses such as rent, utilities, and phone bills in the next 2 months. You can add a buffer if you’re uncomfortable with the small amount in your current account but just keep in mind that a bigger buffer might tempt you to overspend. The size of your buffer comes down to striking a balance between how risk-averse you are and how disciplined you can be with your spending.
Money you're not spending in the next 2 months can be put to much better use in an interest-accruing account or investments.
Have enough money in your emergency fund
Ideally, your emergency fund should cover at least 6 months of living expenses in case life throws you a curveball. Your emergency fund’s value should at least keep up with inflation, so putting this portion of your cash in a current account isn’t a good idea. Instead, keep your emergency fund in a liquid, interest-earning account such as a savings account, money market fund, or other low-risk, liquid investments. Because you don’t tap into the emergency fund often, it has time to grow so that it doesn’t lose value to inflation.
Evaluate interest rates when deciding where to put your emergency funds. Banks advertise attractive interest rates, but in reality, only a portion of your balance is eligible for the advertised rate, and often only for a specific period of time. If your emergency fund of RM60,000 is in your savings account, it’s likely that not the entire RM60,000 is earning the rate; instead, you earn incremental interest with each dollar you have under a tiered interest rate, up to a certain balance threshold. For example, if a bank offers 2.5%, you most likely aren’t earning 2.5% on the full RM60,000, instead, you're probably earning 2.5% on RM10,000, and a lower interest rate on the rest. Ouch. Make sure to always pay attention to the fine print.
The key with the emergency fund is to have liquidity you can access whenever life throws you a curveball. Fixed deposit accounts aren’t good options for your emergency fund because you’d have to pay a penalty for withdrawing your money before it reaches maturity.
Have enough for your upcoming expenditures
Money set aside for big short-term financial decisions, such as a home downpayment or paying for your wedding, shouldn’t be kept in cash. However, the last thing you want before making an upcoming purchase is for that money to drop in value because of a market dip.
Put your cash for these expenses in low-risk investment products that earn can a return in the short-term. So, don’t put your home downpayment in a current account until you’re ready to use it but also, don’t keep it in a risky portfolio either. Liquidity and low volatility are critical when it comes to short-term investments. Make sure that with whatever vehicle you select you can easily access your money when you need it.
What to do with the rest of your money
Let the rest of your money work even harder for you. To reach your medium to long-term goals, take advantage of compounding interest and let your money grow exponentially over the long time horizon. If you unnecessarily keep too much cash, you’re missing out on potential returns that could help you reach your financial goals sooner. If you’re not planning to use your cash for monthly expenses, to top up your emergency fund and to pay for your short-term goals, it should be invested instead.
Head on to StashAway’s website to find out more today. There’s even a special promotion for Graduan readers! As always, please conduct your own research before investing.
Photo by Kelly Sikkema and Michael Longmire on Unsplash