Cuapa Asset Management

Archive for the ‘Saving and Budgeting’ Category

People often invest with the idea that their money will be put away for retirement, or education, or buying a house or some other goal for the future. What many forget to do is set some of their money aside as savings for building an emergency fund.

Emergency funds are funds which are set aside by a saver for, as the name suggests, emergencies. They are designed to cover unforeseen expenses which may occur in the future and which someone has not planned for covering.

There are many situations when an emergency fund might be necessary for someone. Sudden medical catastrophes, natural disasters, legal actions, or unanticipated needs to travel, can all have a serious impact on someone’s finances. Most people who do not have an emergency fund already set aside for cases like these need to take out new mortgages with high interest rates, or dig into their retirement or other savings funds—something that nobody should ever do.

The solution is saving for an emergency fund. This offers several benefits to the saver, including:

-Peace of mind in day-to-day life. You never have to worry about the “what-ifs” if you have an emergency fund, because you will already be prepared for them.

-Money for emergencies. You won’t need to deplete your retirement fund or other investments in case of an emergency, and in case you don’t even have those funds, you won’t be completely out of luck and unable to help yourself.

-Interest-gathering investing. Waiting for an emergency to happen and then taking out a mortgage or other loan causes you to have to pay back interest on the initial loan. On the other hand, if you have an emergency fund set up, your money gains interest over time up to the point that an emergency occurs that necessitates using the fund. If such an emergency never occurs, not only did you prevent needing a high cost loan in the future, but you actually added to your retirement savings.

So how do you invest in an emergency fund?

First, you need to make sure that you buy a stable investment. Stocks may be appropriate for long term investing like that which occurs in retirement planning, but you never know how soon an emergency might occur so an emergency fund should not consist of investments which fluctuate greatly in price. A combination of a savings account, bonds, precious metals, and Certificates of Deposit are all ideal for putting into an emergency fund.

Second, consider purchasing insurance. There is insurance available for personal liability, major medical catastrophe, unemployment, and so on. These can add to your payable funds in the case of an emergency.

Third, ensure that you can readily liquidate whichever investments you purchase. If you purchase bonds, for example, they may be stable but some smaller government-issued bonds like those available from Canada and Israel can only be cashed out at certain times and are non-transferable. These are not ideal for emergencies.

With the recession now in full gear, it is important to focus more on saving over spending and investing for retirement. Many people realize this and are eager to set aside their earnings for investments which will reap rewards giving them greater financial stability. This begs the question, “How does one budget their money to accommodate an investment?”

To answer this question it is important to remember that being realistic is the key to investment success. Many will buy investment products but use such a large part of their paycheck in doing so that they cannot pay for other costs such as electricity bills, food, and so on, and they end up having to quickly resell what they intended as a long term investment.

Consider a scenario where an investor researches an excellent equity or mutual fund and decides to spend 35% of their paycheck on investing in it. This investor has to spend, say, $30 each way to make their trade with their broker, but they consider the price well worth it as they expect their investment vehicle to rise significantly over the next few years.

It seems like a great investment idea to save a lot for the future, but the investor realizes soon after the investment that they need 80% of their income to pay their bills and purchase necessities rather than the 65% they have left after purchasing the investment.

So what does this investor do? He or she decides to resell a large portion of their investment in order to get money to pay the bills. This means they spent sixty dollars in unnecessary commissions. Perhaps the stock also lost value in the short term, as well, and the investor lost another fifty dollars. It doesn’t take a genius to realize that constantly buying stable long term investments and selling them within the week can be foolish. This principle applies to not just stocks and mutual funds, but any investment which involves a commission.

The best way to come up with an investment budget, therefore, is to first determine all of an investor’s living expenses, and then split the leftover portion of a paycheck into three parts: Emergency funds, recreation, and investments.

First, set aside some money to cover job loss, potential medical bills, or any other disaster. You should set aside a portion of your leftover money in case a catastrophe occurs, leaving it in an FDIC-insured bank account.

Second, budget a portion of your leftover income for recreational expenses. Don’t invest only to discover that you are going to go into debt to cover your expenses for fun.

Third, invest whatever is left. This is your money to use towards your investments, free and clear of any worries about needing it for future financial obligations.

If you follow this rational approach to creating an investment budget, you will be able to grow your money over the long term without having to constantly worry about digging into it.