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Why you need an emergency fund to thrive during an economic downturn.

The greatest financial lesson from the current pandemic

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The lockdown due to the current health crisis has impacted everyone mentally, physically and financially. However, the financial impact from the lockdown will affect individuals and businesses unequally. While some companies and people focus on surviving, the other group will use all its resources to thrive during the crisis.

So what is the biggest distinction between the 2 groups?

Cash.

Cash is King
Why you need an emergency fund to thrive during an economic downturn.

A recent Fed survey has shown that 40% of American adults are unable to cover a $400 emergency expense. Be in the remaining 60%, or better yet in the top 10%. 

Companies with resilient balance sheets with sufficient cash and low debt can leverage their relatively strong financial position to come out stronger when the dust settles.

The same concept applies to individuals. Therefore, living paycheck to paycheck while borrowing to spend lavishly during good times is attractive in the short term but will come back to bite on a rainy day. 

Cash for companies is equivalent to an emergency fund for individuals.

The term ‘Emergency fund’ is quite self-explanatory.

Why is an emergency fund important?

If you,

  • Have only one source of income
  • Have dependents
  • Need to be physically fit for your career.
  • Have medical issues
  • Live far away from family
  • Are self-employed or a contractor
  • Own your own home( Repairs and maintenance)
  • Want to be accountable.
  • Want to take risks and evolve.

Here’s a simple guideline to build an emergency fund,

  • Allocate a percentage of your paycheck(5-10%) to a high-interest savings account.
  • Go a step further and automate it. Then, forget it exists. 
  • Maximise your offset home loan account if you have one.
  • Save at least 6 months worth of living expenses
  • Learn to invest and invest the rest.

Guide to high-interest saving Providers

If you haven’t noticed, most banks in Australia, have a very attractive savings rate for a specific period which reverts to a much lower standard rate at the end of that period. Current inflation levels are 1.8%  and saving money in a low-interest account will diminish your purchasing power significantly. 

With the extraordinary money printing era we are living in, expect purchasing power to diminish further and inflation to rise higher in the not so distant future. To protect your capital in the long term, consider investing in strong companies, index funds, hard assets including gold and real estate.

Some banks offer relatively high ongoing interest rates which are far more useful to build an emergency fund. The main reason behind digital banks such as Ubank, Up and ING providing higher rates is due to their lower overhead costs.

  1. Base rate and bonus rate: To qualify for a bonus rate, you need to meet certain criteria. For ING, you need to deposit over $1000 per month and make 5 transactions. 
  2. Backed by the government: The Australian Government guarantees deposits up to $250,000 in Authorised Deposit-Taking Institutions (ADIs)
  3. ATM, transaction fees and monthly fees.
  4. Other features that are of interest: Home loans, Insurance options, Benefits
  5. Ease of access: Mobile platform, Pay ID, Customer service.
  6. Rebates: Foreign transaction rebates. Rebates can potentially save hundreds of dollars while travelling and eliminates the need for foreign money exchanges.

Click here for a list of providers with the highest savings interest rates.

My personal strategy since 2019.

Barefoot Investor by Scott Pape was my gateway to finance and investing and he covers these simple yet effective personal finance tips in much more depth. Ever since I started learning about finance and economy, I was itching to get into the markets and compound my money. 

With the longest bull run in history and relatively overvalued markets, I held back and focused on building my emergency funds. The rule of thumb for emergency funds is 6 months but I decided to have an extra layer of safety. 12 months is enough to completely change my career path if need be.

Afterwards, I continued learning and documenting how the markets moved and saved my money for a potential downturn.

Recession-proofing yourself and your business

Companies Individuals
Strong balance sheet Emergency fund
Net positive cash flow Living below means
Low gearing/Low debt Low credit card debt, Not a victim of buy now pay later schemes
High Return on investment(ROIC) Invests in personal development and skills.
Multiple revenue streams
  • Subscriptions based
  • Advertising
  • Renting/Leasing
  • Product sales
Multiple revenue streams
  • Rental income
  • High-interest savings account
  • Dividend income
  • Consulting
Cash reserves to access short term opportunities 
  • Low advertising costs, low pay per clicks.
  • Buyback undervalued assets
  • Expand and develop existing business models) 
  • Retaining employees during tough times
  • Avoid interest from loans/ Dilution through recapitalisation.
Cash reserves to access short term opportunities
  • Buy undervalued assets
  • Avoid interest rates 
  • Start a business
  • Help people in need
Examples
  • Berkshire Hathaway(Cash- $128Bn)
  • Amazon(Cash- $55Bn)
  • Apple(Cash- $107Bn)
  • Facebook(Cash- $55Bn)

In contrast, over-leveraged companies with high debt and low cash balances are hoping for government aid and investor aid through recapitalisations in times of economic hardship. 

Learn and evolve

An emergency fund has never been this important.

Every crash has taught us invaluable lessons. The people who will benefit the most from this crash are those who already did the hard work by exercising the discipline required to build their position while the market rallied. Now, they are in a position to thrive during the crisis.

If the dot com crash did not happen in 2001, we would have much more speculation. In 2008, if the global financial crisis(GFC) did not happen, the banks wouldn’t be as strong as they are today.

If we look deep enough, this will be just one of many lessons to be learnt from the current crisis.

“While most people are becoming incredibly defensive financially, the world’s wealthiest are gearing up to deploy billions in an effort to buy all the cheap assets. Educate yourself. No one is looking out for you.” – Anthony Pompliano

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