Everything you need to know about having a short term capital reserve

Now that you know the importance of having an emergency fund, we can move on to talking about your upcoming big-ticket purchases. Remember, you need to have your emergency fund sorted out first!

car keys

Most of us have some kind of an idea of what we want to spend our money on. Every now and then we like to treat ourselves and buy something more expensive – it could be the latest smartphone, a new Vitamix blender or a new car. Other times it could be some repair work on your home or home renovations. These expenses need to be budgeted for and appropriate savings set aside. As mentioned earlier, you should not dip into your emergency fund for this kind of spending money or more formally for this kind of capital expenditure.

I think most people tend to “wing it” when it comes to budgeting. This can work for some but it isn’t always the best route as you might overlook one expense by paying for another one and can run into trouble later. This post will tell you what you need to keep in mind to effectively manage your upcoming big-ticket expenses.

What do you mean by short-term expenditure?
A good rule of thumb is to think ahead of the next 3-5 years and think about what upcoming expenses are on the horizon. Going any longer than that will make your estimates less accurate and therefore less useful. However, we can get a relatively good idea of what the future holds for us in the next few years. This could be an upcoming dream holiday, saving for a mortgage deposit or a new car purchase.

Short term can mean less than 3 years and also for more than 5 years. It depends on what you have planned for the future and where you are in your life. For example, a young couple might be thinking about buying their first home but their parents would be thinking about repairing the roof or building an extension.

How much should you set aside for your short-term capital expenditure?
This is an impossible question to answer as everybody has different upcoming expenses. Simply work out what things will cost over the next couple of years and add it all up. Simples.

Should you borrow?
In short, no. I’m anti-debt, especially against consumer debt. If you need to borrow money to buy a smartphone, then you shouldn’t be buying that smartphone. You can’t afford it. Stay away from debt wherever you can and consider alternatives such as buying second hand or opting for cheaper goods and services.

Where should you keep your short term capital expenditure?
One option would be to simply keep it in cash, similar to your emergency cash. However, the key distinction here is that you know when the big-ticket expense will happen. You also have some control over the expense as you may decide to delay it, bring it forward or cancel altogether.

Because of that added control, you can now think about using safe short term investments for this type of expenditure. If you have a £10,000 expense coming up in one year’s time, then you could put £10,000 into various bank accounts to earn some interest. You can even decide to lock the money away for 6 or 12 months or even longer to earn better interest.

banks

There are many banks and building societies who are more than happy to take your money and pay you a bit of interest. There’s no point in recommending a particular bank’s account as the offers keep changing all the time. Make sure to check a particular account’s terms and conditions as quite often they’re something like “earn 5% interest on up to £2,000 of your savings”. You might need to open a few accounts with several banks to maximise your interest. This is not for everybody – especially not for people who hate opening accounts and can’t be bothered. I know my girlfriend would rather earn zero interest or even pay for the privilege of having her money held in an account if it would prevent her from having to fill in a form which asks for her address details covering at least the last 3 years (speaking from experience here).

person holding coins

I’m sure you’ve noticed that interest rates are very low right now. The Bank of England lowered its interest rate to 0.1% and the Federal Reserve (in the US) lowered it to 0.25% only a few weeks ago. Inflation is at 1.7% and 1.5% in the UK and US respectively right now. You might think that keeping money in cash will guarantee a loss in real terms as you are unlikely to beat inflation with your cash savings. This is very true and I think it’s unlikely to change any time soon. However, this does not mean that they do not have a place.

Investing your money in the markets will introduce risk to your capital and you can end up with less than you started with. This is especially the case over the short term. To be clear, when I say short term I mean anything below 5 years. There will be a post in the future shining some more light on this but the gist of it is that the longer you’re invested the lower the probability of suffering a capital loss. This is because markets have an upward slope as they tend to go up over time.

One option is to consider using a savings platform. These are essentially cash management platforms, where you create one account (a hub account), deposit your money and then select various bank accounts to deposit your money into. The benefit is that you only open one account with the platform and then pick the various bank products you wish to split the money form your main hub account. This removes the need to fill in forms to open new accounts with new banks and building societies. You will also have an easy overview of where all your money is held and how much interest you are earning. Bigger savers will also benefit from added security as UK deposits are FSCS protected up to £85,000 per bank, building society or credit union – you can increase this by spreading your savings over several institutions.

The only downside is that these savings platforms charge for their services. This tends to be 0.25% p.a. or similar on anything held on the platform. So, you should expect to earn slightly lower interest than going directly to the providers with your savings.

Taking the above into account, if you choose to invest some money which you need in say two years’ time, then you might actually end up with less than you have today. There’s no need to risk your hard-earned cash like this.

You can also look at the savings products offered by NS&I for your short term investments. These are backed by the UK government and its printing presses. Therefore, your money will be as safe as the UK government.

To be clear you should not invest money in the stock market where you intend to access it within the next five years. Also, avoid any peer-to-peer (P2P) investments as it can take ages to get your money out of these platforms (speaking from experience).

Interestingly, I heard of a creative/unusual way of earning more interest on your money. This example is from Sweden where the local central bank i.e. Riksbank has kept interest rates at zero or below (yep negative) for the last five years. However, it is possible to overpay your taxes in Sweden and earn a minimum of 0.56% p.a. interest on these payments. This has resulted in massive overpayments and a budget surplus a few years ago. They changed the rules and now Swedes don’t earn any interest on their overpayments and many received refunds.

That example is not an attempt to encourage you to think outside the box to increase your interest. There’s plenty of scams out there. If it sounds too good to be true, then it’s probably a scam. For example, anybody who offers to take your money in exchange for a guaranteed 10% annual return, is full of it. Stay away!

Summary
I hope the above has convinced you to keep your short term capital expenditure in cash or low-risk cash investments. You now understand why it’s important to keep this money separate from your emergency cash and why it should be in safe investments. I have shared some of my ideas on how to invest your short term money and what kind of investments to avoid. Go ahead and check out some of my ideas (Google is your friend).

TLDR
Short-term capital expenditure includes your future big-ticket expenses which will happen within the next 5 years. You have control over this type of expenditure and that’s why you can choose to invest in safe cash investments to cover it (as you will be able to access your money when or before you actually need it).

Similar posts:

You need an emergency fund – this is an emergency!

Why do you even need an emergency cash reserve?
Things will always break down. In fact, some things are designed so that after a certain amount of use they will break down and you need to buy a replacement. Wikipedia defines this as follows: planned obsolescence in industrial design and economics is a policy of planning or designing a product with an artificially limited useful life so that it becomes obsolete (i.e., unfashionable, or no longer functional) after a certain period of time. The rationale behind this strategy is to generate long-term sales volume by reducing the time between repeat purchases (referred to as “shortening the replacement cycle”). It is the deliberate shortening of a lifespan of a product to force consumers to purchase replacements.

tap

Look, your car will malfunction, your boiler will stop working and at some point, you or your partner will lose their job. If you don’t have some cash set aside, then you will have a big problem once something like this happens. These events can be expensive, stressful and a massive pain in the backside.

Fixing your car or replacing your boiler might cost £1,500 and finding a job could mean months of unemployment and many interviews until new gainful employment is found.

Things can get even worse (sorry). In the broken car scenario, you still need to get to work. If you’re unable to get to work, then your earnings are likely to reduce, which creates additional financial hardship. You’re also unable to pick up the kids from school and need to ask a friend or relative for help. You might have to take a taxi or an Uber to work instead and this is a new unwelcome expense.

If your boiler breaks down and you have no warm water, then you can’t enjoy your morning showers any more. Imagine you suddenly had to take cold showers until your next paycheck. I tested having a cold shower the other day and survived, but it was unpleasant. Now, throw in some children into the cold water situation and you will see how important it is to get the boiler fixed as soon as possible.

If something similar has happened to you, then you’ll know that it’s difficult to go on with your life as you normally would if you don’t have any cash set aside for the what-ifs of life. Having a pot of money tucked away for emergencies provides you with additional peace of mind knowing that you will be financially OK if something were to break down or you lost your job or something similar.

There are other benefits – for example, having set aside 6-12 months’ worth of your normal expenditure, will provide you with a “financial runway”. You will feel more at ease if you hear rumours that they might start making people redundant at work. Having some savings set aside might also give you enough confidence to start out on a new business venture because if it fails, you will have enough money to sustain yourself throughout a lengthy job search. That new business might be your ticket to happiness and financial security.

Ask yourself, how much “job security” do you really have? Most people have a 30 day notice period at work. What about sickness? How long will you get paid your full salary if you can’t go to work for a few weeks? Is statutory sick pay going to be enough? How safe do you feel? Do you already live payday to payday?

An emergency fund is also important for people in situations where they end up in abusive relationships. It’s difficult to leave and start your life again somewhere safe if you have no money to your name. I’m not an expert in this area and don’t know about all the things you need to consider before leaving an abusive partner. However, I’m sure money would help with that.

There are occasions when you need to suddenly drop everything and travel somewhere. I hope it never happens to you, but you could need to travel for a funeral because of a death in your family. You might need to buy an expensive flight or train ticket on short notice. There might also be accommodation costs and potentially a reduction in your earnings as you’re away to be with your family. That would be a difficult time for obvious reasons and adding money worries would only make things worse. It doesn’t have to be like this.

As you can see there’s plenty of scenarios where having an emergency fund is the solution. It’s not the only solution, but it’s the best in my opinion. You could probably borrow some money or use your credit card etc but these could create further problems if you’re unable to service the debts. It’s a slippery slope and I’d steer clear from that path. The emergency fund is a much better solution as it doesn’t have any big downsides.

There are a few things you should consider before you start an emergency fund. This post will tell you what you need to know to make sure you build up an emergency reserve so that you are in a good position when things don’t go as planned.

bank notes

So, what do you need to keep in mind before starting to save for an emergency fund?
First of all, if you’re already struggling with debt, have maxed out all your credit cards and owe money to your friendly neighbourhood loan shark, then this post isn’t for you (but I’m glad you’re reading it). You’ve got bigger fish to fry and should not be thinking about having an emergency fund. You need to prioritise paying off your debts. Seek debt counselling from a reputable charity if need be. Godspeed.

If your financial situation is better and you are OK with paying all of your bills and have some extra money each month, then you are in a good position to start saving. It’s important to realise that you need to dig your well before you’re thirsty. This means that you have to plan before the emergency happens. If things are good at work and you’re healthy etc then now is the best time for you to start building an emergency cash reserve.

How much do you need to save for emergencies?
There are many numbers thrown around on the internet and everybody will give you a different figure. It’s quite subjective but 3-12 months’ worth of your normal expenditure should do it. So, if you spend £2,000 per month, you should aim to save up at least £6,000 for your emergency fund. If this sounds too hard, then you could look at what your essential outgoings are and cut out all the excess. Say it’s £1,500 per month. In that case, you would need a cash reserve of at least £4,500.

If saving up 3 months’ worth of expenditure is too difficult, then aim to save as much as you can. One month’s expenses saved up is better than nothing. It’s important to start the saving habit.

The upper end of 12 months is also subjective. You could opt for more if you wish and this is a personal decision based on how much safety you want to have in life. I think you need to be a bit wealthier than the average Joe to have more than 12 months’ worth of cash set aside for emergencies.

It’s important not to treat your cash reserve as a miscellaneous savings pot. You should not dip into this pot to fund your holiday, buy a new electronic gadget or spend it on booze and cigarettes. This is important and you will be very glad you have this money set aside when you need it. The purpose of this money is to have insurance. That’s how all insurance works – you buy it precisely because you don’t want to ever have to use or need the sum assured.

Where should you keep your emergency cash reserve?
Simply put: in the safest place you can think of. If you don’t trust the banks, keep it under your pillow. If you think somebody will find it under your pillow and run away with it, then keep it in the bank. If you’re worried about both of these then diversify.

The main criteria to look for are ease of access and safety. I mean, don’t lock it away for 12 months to earn 1% of interest on it. Remember, this is money you need to have access to at a moments notice. This is an emergency!

You could open a second bank account to keep these monies separate from all your spending money. One option is to consider opening an account with NS&I as well because they are backed by the UK government. I’ve created a short video below about the different products available on NS&I.

NS&I is essentially a way for you to lend to the government and earn some interest in the process. Your bank might go bust but the government is quite unlikely to go bust (especially here in the UK as the government can simply print more pound sterlings left, right and centre). Therefore, your monies in NS&I will be very safe. You could choose from several products such as Premium Bonds for example. Have a browse on their website. A lot of people like having Premium Bonds as these receive “prizes”, where the maximum could be £1 million. Effectively, you’re getting lottery winnings rather than earning interest with Premium Bonds. Please note it can take a couple of days to get your money out of NS&I. One option to consider is to keep a few thousand pounds in a bank account, keep some in cash at home and the rest of your emergency fund with NS&I. It doesn’t have to be all-or-nothing.

Should you invest your emergency cash reserve monies to improve the return you can get on it?
You might be tempted to invest your emergency fund instead of keeping it in cash. It’s true, interest rates are at all-time lows and you could make some sweet-sweet gains in the stock market if you YOLO it all on Tesla stocks or buy a few good old Bitcoins. After all, you could just sell your investments and then have access to your money. It will take a few days to withdraw the funds into your bank account, but it’s fine you say to yourself. The problem with this approach is that you might be forced to sell your investments at a bad time e.g. when the markets are down (stock markets crash every decade or so). Right now (during the Covid-19 pandemic), would be a bad time to sell investments and realise your losses but you are dealing with an emergency.

There’s another danger with investing your emergency monies. You could be unlucky and make investments in funds, which suspend their dealings (this means nobody can buy or sell your investment for a certain time – this is what’s happening to real estate/property funds today for example). Now you can’t even sell. Liquidity (the ease of selling your investment) is important. Cash has perfect liquidity.

If you’re sensible with your investments, then you might be OK using “boring” investments (such as money market funds) for emergency fund purposes. However, I would recommend keeping it in cash. You know what they say – cash is king. Don’t forget you have an emergency on your hands. Keep it simple, stupid!

TLDR
Emergencies will happen, things will break down and you might lose your job. Build a cash reserve, which will provide a huge help with a myriad of stressful situations. Aim to save 3-12 months’ worth of your normal living expenses and keep these monies in a safe easy-access bank account.

Now you know why you need an emergency cash reserve, how much you need to save and where to keep the monies. Go ahead and start planning for the inevitable emergencies today.

Similar posts:

Happy new tax year 2020/21

Today is the first day of the 2020/21 tax year. I’m able to fund my ISA and LISA again as last year I managed to max out both of them.

So, this morning I topped up my LISA with £4,000 and invested it. I expect to receive the £1,000 LISA bonus payment around the end of May and will invest that once received.

Going forward, I will make regular monthly contributions into my ISA (remaining allowance of £16,000 as I just funded my LISA) and at some point when the markets are less volatile will use my GIA to fund the ISA as well.

I asked my ISA provider if it was possible to fund my ISA from the GIA with an in-specie transfer i.e. transferring the assets in the GIA into the ISA without having to sell them to cash beforehand. This would have avoided any potential issues with being out of the market, but unfortunately it’s not possible with my provider (not sure if any other provider would allow this). It was worth a shot anyway. Therefore, I’ll wait for things to calm down a bit.

I realize my remaining cash (or emergency fund) is now around £5,000, which means it covers about 3 months’ worth of my expenditure. I think I will prioritize adding money to my portfolio rather than increasing the cash level in the coming months as I believe markets present a good risk-reward ratio right now. So buy buy buy!

You might remember that I was planning on buying a flat with my girlfriend but the pandemic is making this more complicated. We have already agreed to buy a flat but there’s some kind of issue with the transfer of the leasehold, which has taken up at least 6 months already. Our mortgage offer will expire next month and I have a feeling banks will make it much harder to get a mortgage as they are likely to increase their deposit requirements. So, we might not be able to get another mortgage offer for quite some time. It’s not looking good and we’ve been thinking that property prices could come down as well… So we might be better off buying a bit later.

Enjoy the sunshine!

Similar posts:

Investing for the long term

What should I do when the market turns negative? Well, let’s have a look at the market over the last 100+ years (Feb 1915 to April 2020). I’ve generated a chart of the Dow Jones below (please note the y-axis is on a logarithmic scale). The chart looks pretty good if you ask me. It is clear that the direction of travel is up.

Dow Jones February 1915 to April 2020, logarithmic price chart, recessions in gray

That chart gives me a lot of confidence in investing and not worrying about the noise or news or the latest tweet from a president. Things will work out in the end. They always have – after two World Wars, many crashes, many recessions, many scandals etc and now probably after this pandemic as well.

I’m 32 years old and am expected to live until 85 according to the ONS. So, I’ve got 50+ years left in the tank. Even after I retire, I will continue to be invested. Therefore, my investment time horizon is my entire lifetime.

So, is now a good time to invest as markets have come off 20%+ from their highs? Based on the long-term chart, yes and in fact, any time is a good time to invest.

I will continue adding to my portfolio as I normally would even in the current investment climate and hopefully, my wealth will look a lot like the Dow Jones chart over time.

Wealth update – 31/03/2020

The markets are now closed and I have updated all of my portfolios (see my Wealth page for details). Unsurprisingly, March has been a negative month.

The only things which increased were my cash holdings and my pension. This is because I topped up my cash from my salary and sacrificed my bonus into my pension. All of my investments have lost money across the board – however, I kept my EIS valuations the same as last month as these are illiquid and it’s not possible to get a market value.

Not only did I get a bonus, but also a tiny 1.8% increase to my base salary – this, I presume, is to keep my salary in line with inflation (CPI is 1.7% right now based on Bank of England’s website). Better than nothing I presume and it’s always nice to see an increase in my earnings. My net salary will increase a tiny bit from next month as well as HMRC announced an increase in the national insurance bands. So, this has been a modest improvement.

However, my rent has increased by 4% and council tax has increased by 3.5%. These two largely negate the increases in my earnings.

I also switched my mobile service provider as I found an even better SIM-only deal than I previously had. Now, I’m saving a fantastic £1.05 p.m. on my mobile phone bill – I only pay £4.95 p.m. and get 2 Gb of data plus calls and texts, which have some limits but I hardly ever call anyone – and when I do I use WhatsApp. #Millennial The saving is small but still worth doing.

Next week, on 6th April, the new tax year will start. I plan to top-up my LISA with £4,000 from my current cash and invest it. Once the £1,000 LISA bonus is paid in (this will probably take 6-8 weeks), I’ll invest that as well. I’m going to hang on to my GIA monies for a bit as the market is very volatile and I don’t want to move it to my ISA just yet (as that would require a sale in the GIA and then buying it back in the ISA and maybe a few days of being out of the market). I will fund the ISA with my GIA later in the year when things have calmed down a bit.

I also started an application for critical illness insurance. However, the insurer needs to get a medical examination and a GP report, which are difficult to obtain during times of a pandemic. This is delaying things, probably for a couple of months. I estimate this to cost about £45 p.m. once it’s set up (I’m applying for a £100,000 critical illness sum assured with £100,000 of life cover to age 70, where the sum assured increases with inflation).

Why am I getting critical illness cover? Well, to cash in if I get cancer or some other horrible illness. For example, 1 in 2 UK people will be diagnosed with cancer in their lifetime – so if this happens before my age 70, I will get the sum assured and treat myself. The £100,000 figure is sort of random as I didn’t really know how much I need – on the plus side, I’m able to increase it during certain life events e.g. buying a home, having a child – without any need to do any further medical checks (but I will have to pay more each month to reflect the larger sum assured). So I’ve got some flexibility.

I find paying £45 p.m. quite expensive for £100,000 of cover, but the fact is that I’m not getting any younger. The later I leave it the more expensive this will become.

My girlfriend (24 y.o.) got the same insurance policy (but with a 40-year term as it’s more than 40 years for her to reach age 70 and the maximum term was 40 years). She was accepted without the need to provide any medical tests or GP reports and got the policy on the same day as we applied for it. I think it cost about £28 p.m. for her, I’m not sure. Oh… to be young…

And that was the month of March 2020.