Mar 10, 2009

Rules of Thumb .... And How To Have Better Thumbs

Here's some conventional wisdom from the world of personal financial planning. One of your early goals should be to build emergency reserves worth about six times your average monthly expenses. For example, if you usually spend about $3,000 per month, then you aim to build emergency reserves of about $18,000. This amount should be held in cash, not stocks or bonds or something else.

The idea is that if a person suddenly loses his job, he will usually succeed in finding a new one within six months. Thus if his emergency reserves are all nice and ready, then it can adequately sustain and support his usual lifestyle until he finds another job. The reserves should be in cash, because that's the safest, most liquid asset.

Two assumptions here. Firstly, that six months is enough time to find the new job. In more-normal times, this may sound reasonable. But current times are proving to be somewhat extraordinary. So quite arguably, the "six times" figure should be revised upwards, say, to "nine times".

The second assumption is that if you lose your job, you will largely continue to live the way you lived before, and therefore incur roughly the same amount of monthly expenses. In practice, this assumption could turn out to be true in many cases. Why?

Because when a person suddenly loses his job, he may not adapt quickly to the changed circumstances. He may promptly cut back on some smaller, more easily cuttable expenses (for example, eating out less often). However, there will inevitably be psychological resistance to the bigger lifestyle changes (eg giving up the car, or the maid).

Some of this psychological resistance will arise from the person's hope that perhaps he'll find a new job really quickly (eg maybe tomorrow, or next week), and therefore he doesn't really need to make any major lifestyle changes. The hope isn't necessarily unjustifiable or irrational. But it's important to have a Plan B ready, just so you're not unexpectedly caught with your pants down.

The way I see it, the trick to dealing with the psychological resistance is that even when you still have a job, you should start becoming very clear on what you've been spending it on. Then you'll know exactly what you need to cut, if it later turns out that you really do need to cut. Gather the information now, when you still have a calm, clear head. Don't wait till you actually lose your job, by which time you may be too upset and your emotions start getting in the way of rational decision-making.

Right now, do you know how exactly you've been spending your money every month? If you don't, there's a good chance that you're wasting some of it. And let's say, for the sake of discussion, that starting from tomorrow, you have to spend 30% less every month. What decisions would you make, which parts of your lifestyle would you adjust, to immediately bring your expenses down to that level?


Anonymous said...

I agree that when a person is jobless it is easier to cut back on the smaller expenses, but not the larger items, like the car because of the psychological resistance.

More than the psychological resistance is the perception that it is a loss of face taking public transport, when all your life your neighbours see you drive a car.

The second more obvious reason for keeping the car is perhaps the negative value in relation to the loan, when the proceeds from selling the car is still not enough to pay off the loan. Many are now stuck in this situation.

So, sometimes it is not a matter of just cutting down, it is also a case of being aware of what others have gone through that gives us valuable lessons which we should learn, in order to avoid the same pitfall.

Lost Citizen

Kaffein said...

First post? Woot!

Anyway, I have had friends whom after getting married bought a car and also bought an EC/Condo (it was close to 0.5mil at that time). Now that's so scary. Even after so many years they are still paying for their loans. For me? 4-room flat and slowly upgraded. It's their choice anyway.

In addition to your wonderful advice, Mr Wang, I will like to add some of the 'weird' ones I've been adhering to:

1. Know your cashflow and expenditure well. No use earning $4k and spending $3.5k, leaving you with so little each month to save.

2. If you know the above well, and have saved quite a bit, know how long you can hold on to your investments before letting it go. This ensures you are able to keep your head above water should you get hit by some downturns.

3. Get a second, third opinion when going to purchase something substantial, eg car, bonds, etc. Give yourself at least 1 month cooling down period (for me I take at least 2 months). Even better, keep discussing with your spouse until either of you turn blue. Then you'll really know that you are serious in buying it.

3a. What happens if it's so hot to buy that it can't wait 1 month? Easy is as easy does, you'll probably lose it quickly too. If not see next point below.

4. Rule of thumb for myself when going into investments: If you are not prepared to lose everything, don't even bother.

These are just rule of thumb. A bit unorthodox and not the norm, but hey it works for me.


Anonymous said...

For any action or inaction, consider the "worst case consequence". Can take it? If can't, then do the right thing to avoid it.

The scenario of having to borrow, see MP or get charity help and losing dignity is enough to make me save not just 6 or 9 but many times salary. Of course some can take it but I can't.

KayAngMo said...

This summary is good and i will now go and do my sums. Thanks Mr Wong!
Best regards,

Anonymous said...

Most people who talk big on the Internet about other people who can't cut down on expenses...are usually the ones who refuse to give up anything when trouble stares at them in the face.

Anonymous said...

You are assuming someone is already spending on luxuries.

What about those who is already spending on necessities and has nothing much to cut ?

Life is not as simple as text book models :(

Mr Wang Says So said...

Oh. Basically you're screwed then, LOL.

Mr Wang Says So said...

Seriously, if people look at their problems, and their attitude is: "This can't be done ... That can't be done ... There is no way ..." ...

Well, then, they ARE screwed.

David said...

Well Mr Wang I absolutely concur with what you have said. It sounds really logical that it IS the psychological resistance that is affecting people.

A great number of people are really unaware of their spendings. These people are seriously dumb morons at financial literacy.

Jim said...

It depends on what you think are necessities. Middle class Singaporeans don't really know what necessities are.

Just some examples - aircon, handphone (monthly billing), tissue paper aren't necessities.

Anonymous said...

Thanks for the post!

If you have ever considered whether the usual debt to income ratio is a good method to think through personal finances, it would be great if you could blog about some of your thoughts about it.

Vincent said...

Some of the good money management habits I have learned upon uni graduation is to have a personal accounts sheet. I have been following it religiously the last 3.5 years. All my expenses are accounted for and a monthly evaluation is done to ascertain whether the expenditures necessary. As a single adult staying with my parents, the p.a. expenditure is around $20k (half goes to parents). All these savings here and there can accumulate to a lot.

chengguan said...

if u dunno the sum and u agree with mr wang, go talk to a financial advicer. let the professional help u calculate. (of coz, buying products from him afterwards is another decision altogether...)

Anonymous said...

Dear Mr Wang

U work in an IB.
IF every1 does the sensible thing, you will be scr*wed :-p

What about the rule of thumb that says annual household income : cost of property ratio should be ard 1:4?

That would scr*w the property market.

On 2nd tot, I think more fools the better.

Anonymous said...

"face" value in sillypore is extremely important. Half of the time ppl are comparing who got the better car, condo etc etc.

Also SGPrean leave on credit, car/house/renovation/electrial and wat else loans. there are instances where there will be "peer" pressure to upgrade.

There is a misconception that the expenses need to be in line with the increase in income, which is not correct. Once you covered the fixed cost (what you die die must spend monthly), then work to maintain at that level and minimise the variable cost (dining out, partyng etc)

I am lucky as I do not have any of the above (ok... HDB @ 3% of income) and monthly expenses is at 20% of income.


Jimmy Mun said...

The rule of thumb is that there is no rule of thumb.

When Iceland was veering into bankruptcy, what did the Icelanders do? They rushed out to buy luxury items like Rolex watches, because owning anything of some value is better than owning rapidly devaluing Icelandic Kroners.

Just 2 years ago people were debating how stupid it is for our CPF monies to languish in poor performance instead of handing it out to professional money managers. Like GIC or Temasek. What a difference two years make. I dont know about you guys, but the my uninvested CPF was the best performing asset for me in 2008. And note, I am not out to knock GIC or Temasek. I think they performed extremely well overall, compared to my stock portfolio (decimation is a very accurate description, 90% loss). It's just a shame when they make some investments that has more strategic than investment value to Singapore, they tend to blow up spectacularly.

I dont know what lies ahead. It's hard to imagine how massive US deficits will not lead to USD devaluation, but we are living in strange times. Maybe the deleveraging will continue for years to come, and cash will continue to be king. Or maybe we will go into hyperinflation and we will need wheelbarrows of money to buy a loaf of bread.

My best suggestion is to take the middle path. Save a little, spend a little. Buy a little gold for a loved one, go on a holiday overseas and keep some foreign exchange. Even in the Great Depression, there was an 80% employment rate. The downturn may be the best time to do some serious spending, provided you managed to hold back during the boom times. Just be ready for the inevitable wage cut if this downturn last for years and years.

I was unemployed/underemployed for nearly 4 years, and the biggest regret is that, although I had no financial difficulty because I had savings and a working wife, I let fear gripped me for those 4 years. I had plenty of time to do anything I want, and I did nothing in the name of frugality. 4 lost years. Now I have plenty of income but no time.

Oh wait, there is a golden rule of thumb. Dont go to an insurance agent for financial advice. The only tool in their toolbox is whole life insurance, because it will earn them the most commission, and because it is the only advice they know how to offer. Not to mention there is possibility that we may actually outlive some of the insurance companies.

CA said...

"Save a little, spend a little. Buy a little gold for a loved one, go on a holiday overseas and keep some foreign exchange... I let fear gripped me for those 4 years. I had plenty of time to do anything I want, and I did nothing in the name of frugality. 4 lost years. Now I have plenty of income but no time."

Well said Jimmy. I know it's hard in tough and uncertain times like these, but keeping a little perspective goes a long way.

What exactly are we hoarding all our money for? Sustenance? Fine. But there's no point in saving because that's the "right" thing to do when times are tough.

Go on a vacation, spend money on and time with friends/loved ones, buy a car if that's what you're into. There's no point sitting on a pile of cash and looking back at how empty your life has been.

Save enough to live on. But beyond that... life's too short.

Anonymous said...

Yo Jimmy

Consider the 4 lost years a blessing and a valuable lesson learnt.

Dont knock urself on investment losses!
For all ur know, GIC\Big T might come crawling to Mr Wang soon for advice on the toxic stuff :-p

On one hand it is obvious that you have no idea what 80% employment means. On the other hand, they say the worst worries are those which will never happens. (but do look out for the day when even Mr Wang starts sporting the lightning logo)

So the best rule of thumb is to live for the moment :-)

Anonymous said...

A plate of mixed food or chicken rice is still $2.50 at the neighborhood hawker centres.

I think $10 per day will more than suffice per person for 3 square meals.

Today, government's welfare for the unemployed and needy aged is enough.

In some countries, women continue to produce like rabbits cos the state welfare is tied to the number of children per woman. The more children you have the more money you get. So these women stay at home, produce, and collect taxpayers' monies as free income.

The said...

/// compared to my stock portfolio (decimation is a very accurate description, 90% loss). ///

Jimmy - just thought you would like to know - "decimate" is a commonly misunderstood and misused word. Though it is usually used to mean reducing by great numbers, it actually mean reduction of 10%, i.e. 1 in 10. Kill one in every ten.

Yours is more like a wipe out. Let me guess - you your mostly invested in financial stocks.


Anonymous said...

"Most people who talk big on the Internet about other people who can't cut down on expenses...are usually the ones who refuse to give up anything when trouble stares at them in the face."

hello, how to cut down when already earning only 1k a mth?

Anonymous said...

If you are staying around one of those Junior Colleges you can get a meal eg chicken rice, mee rebus, mee soto for less than #2. But of course that's only available during lunch time. Not too bad in terms of taste, but nowadays even hawker centre food is not that good either.

Roy said...

To Anon

March 11, 2009 2:05 PM

3 square meals per day at $2.50 each works out to $7.50 a day.

There are other basic necessities in addition to food. Examples will be medicine, housing, transport, utilities. Are you sure the remaining $2.50 a day can cover that?

Anonymous said...

Jimmy Mun : "My best suggestion is to take the middle path. Save a little, spend a little. Buy a little gold for a loved one, go on a holiday overseas and keep some foreign exchange."

Yep, to totally cut down on expenditure in the midst of gloomy news is so easy. But the cost of owning a used car has gone down alot. And so hubby decided to swop our 6-yr old car for a dream car that he had always wanted. :-)) We'll not be able to do so during the boom times.

James said...

To Anon

March 11, 2009 2:05 PM
"Today, government's welfare for the unemployed and needy aged is enough"
i hope that you are kidding. What welfare are there for the unemployed especially those in the lower middle class. Workfare we cannot take being unemployed and only for those with salary lesser than 1500. We cannot apply for any of the PA since our previous salary is too "high".

Savings is king for the unemployed middle class. the only solution the government provide for ours is the pathetic income they give us for going for retraining. Retraining is useless for professionals since most jobs require experience and no company will hire a fresh person in a downturn.

Jimmy Mun said...

Thanks for the tip on decimate. Guess I have to use another word...obliterated, pulverised, annihilated, pwned...

I'm quite over my stock losses. They were mostly China stocks, and most of the damage were done in late 2007 to early 2008. I was trying to bet on a "SGD devaluing/The world goes into hyperinflation/Asia will suffer less as US falls apart" scenario.

Part of the reason why it looks so bad is because I broke the cardinal rule of investing, and sold the winners while hanging on to the losers. It probably wont look so bad if I take the sold winners into account.

But enough on me.I think everybody who bought and held on to stocks would have lost money in 2008, and if GIC/Temasek only lost 30-40%, that wasnt so bad, me thinks.

I still think MAS will allow SGD to devalue and inflation will spike, which is why I am quite sceptical about the cash is king advice, but given my track record, maybe it will be more profitable to bet against me.

Anonymous said...

I'm an old woman on welfare. More than $300 a month from the government. I used to be a clerk in a transport company.

I have some savings. My luch & dinner at the hawker centers don't cost more than $6 a day. I have cup of tea or cooffee for breakfast.

When sick I join the queue at the polyclinic; not often. Quite cheap also.

I aslo get foodstuff from the boys brigate, ccc and other charities.

Life is ok lah for a jobless old woman. I wish to thank the working people for helping us. thank you.

The Lab Rat said...

I do not like the amount of debt that newly-married couples have to take out for a HDB flat. Being in debt does not give me a sense of belonging to Singapore, nor will it ensure commitment. Wonder if anyone will marry me if I suggest that due to financial prudence, we go for a 3-room flat ...

chengguan said...

To Lab Rat:

if the woman loves u, she will marry u. if u loves her, u will work harder for ur future... why is 3-room flat a concern? my wife married me when i had nothing...not exactly, i had $6k saving in my saving account... but that is not enough to buy a 3-room flat as a PR, either...

Onlooker said...

It's better to have opposable Thumb than a thumb that is rigid and cannot even afford to bend even a little bit.
To grasp thing better :)
Maid = luxury because without maids the employer can still cook, sweep, take care of children/ elderly (with the effect of closer bond) and do laundry.
the problem is "Keeping up with the Jones".

Car like cellphone is a productivity device.
Car = mobility.(esp impt for sales /support people)
Phone = accessibility.

Anonymous said...

In this era of job instability, a savings to last for 6 moths is not enough. One should look at 12 months. The US recession is already into its' 15 months and there are still not sign of light at the end of the tunnel.

The said...

/// I think everybody who bought and held on to stocks would have lost money in 2008, and if GIC/Temasek only lost 30-40%, that wasnt so bad, me thinks. ///

Agree, provided IF they lost only 31%-40%. Wall Street is down by more than 50% and the STI is down by more than 60% from its peak. So If GIC is only down 25% from its peak, I think kudos to them. However, the same cannot be said of Temasek. I suspect Temasek's loss is bigger than the declared 31%, which was as at end Nov 2008, when they announced it in Feb 2009. Also, there were the sales of GenCos. Some of the TLCs were bought at very attractive valuations.

So, my guess - GIC outperformed, and Temasek underperformed.

Anonymous said...

I'm at a loss. Just been retrenched. Used to work in a media company. Just folded cos few orders. I'm in my forties.

What to do? Heard everywhere is bad if not worse off. Thought of migrating. My brother himself wants to return from Australia and asks if I could get him a job over here. Real irony. Imagine, even the free-wheeling high term deposit rate there has tumbled to 3% and is expected to dive further. Today's Aussie-$Sing exchange rate is in S'pore's favour. Even such a huge, resource rice continent is melting away.

We all still get to collect Bonus Dividends and GST credits from our government thanks to our past reserves. But for how long more? Pretty scary lah . . . . especially our immediate green neighbors don't always react predictably.

Kaffein said...

To Lab Rat:
I married my wife with only $200 dollars in my bank. I would not lie to you but I hope it encourages you.


Anonymous said...

"We all still get to collect Bonus Dividends and GST credits from our government thanks to our past reserves. But for how long more? Pretty scary lah . . . . especially our immediate green neighbors don't always react predictably."

Our relations with the people immediately up north is close and friendly. However it is the leaders, due to their past baggage and pride, who put a strain on things. The past (the lees) should stay in the past and move out of the scene for Spore's good.

firemju said...

Those suggestions are mainly targeted at jobless middle income persons. It's a very different game for the lower income people.

Earn 1.2k during the boom years, ard 800 now. There isn't much fats to cut, but regardless, 800 is enough to bring food to the table.

What is scary is the prospect that the 800 may be gone very soon.

Anonymous said...

Freddie writes

"The past (the lees) should stay in the past and move out of the scene for Spore's good."

Interesting . . .

Who's the present & who's the past?

Who shd move into "the scene for S'pore's good"?

The Lab Rat said...

Another thing most people can do is to curtail the use of high-electricity consumption appliances.

When electricity prices were high, I stopped using my desktop and used my laptop at home. This meant > 75% reduction in the amount of electricity used. I do not have air-conditioning at home.

A few years ago, I downgraded to a smaller refrigerator, having calculated that the savings in 2-3 years could pay for the fridge.

This required some lifestyle adjustment. Instead of one big visit to the supermarket, I had to make 2-3 equivalent visits to the neighbourhood shops (in other words, "just-in-time" shopping).

This had two advantages. First I saved on transport fares and the hassle of carrying so many things. Secondly, I found that the prices of goods at neighbourhood shops are comparable to the supermarkets.

How to calculate the cost of electricity consumption? Look for a label in your appliance and look for a number with a W, "100 W" ie. 100 watts. Divide that by 1000 to get it in terms of kilowatts.
Multiply it with the electricity tariff you see on your power supply bill. That's the cost of running your appliance per hour.

So, assuming the tariff is $0.18 per kWh, my 100 Watt fridge costs $0.432 per day to run.

Jon said...

The lack of social security means that your thumb has to:
- be bigger
- last longer
- more resilient

Ideally, one should have
- cash enough to last for 6 months.
- zero debt

Life's needs are simple.
Mans needs are complicated.

'填饱肚子', a phrase I learnt from a PDMM.

Anonymous said...

I know of so many working adults who spend the whole paycheque, leaving none. And then they get in their mid-40's and they have close to zero savings. Mind you, they're not far from retirement (age).

Its a very different mentality nowadays. As they say:

"The more you earn the more you spend, so no matter what, you save zero"