~ Annette Sampson ~
The strategy To stash some cash for emergencies.
Do I need to do that? Are you kidding? Hasn’t all the mayhem on world debt and sharemarkets this year brought home the fact that spare cash is a good thing to have? Whether you believe the latest rally is the turnaround point or not, the fact remains that the easy money of recent years has dried up and the resulting credit squeeze has put meaning back into the old adage that cash is king.
There’s not a lot the experts agree on but on one point they are unanimous: the uncertain times aren’t disappearing any time soon. We’re still seeing the unwinding of dodgy lending practices, a recession in the US looks increasingly likely and Australia can’t seem to work out whether the porridge is too hot, with inflation the main problem, or about to become too cold as all those interest rate hikes start to bite.
A cash buffer gives you the security of having money on hand if your personal circumstances take a turn for the worse and the ability to take advantage of opportunities when other people are strapped for funds. In falling markets, investors with liquidity can snap up bargains as cash-strapped investors are forced to sell.
How much of a buffer should I have? Denis Orrock, the general manager of InfoChoice, says his Depression-era dad always advocated having three months’ income set aside to help you get back on your feet if something went wrong. He says that’s still a reasonable ballpark figure, though how much you need will depend on things such as how much debt and other commitments you have.
“[Having a buffer] also frees you up and gives you more choice in life,” he says. “You often see people who don’t like their jobs but can’t afford to leave. But people make decisions if they have money set aside and want to make changes. They reap the benefits of their savings.”
Financial planner Laura Menschik of WLM Financial Group says in uncertain times you need to look at what you can do to make yourself as comfortable as possible. This could mean having cash set aside but it could also involve paying down your debts so that you have money to draw on if you need it.
“If you pay off all your credit cards, you know that you can use them in an emergency,” she says. “Reducing your debt over time gives you access to finances when you need them.”
If you have a home loan with a redraw facility, Menschik says pumping extra money into your mortgage is a very effective buffer as you reduce the size of your loan now (and the interest charged) but can still redraw the excess payments if you need the cash.
“It’s hard to say how much you should set aside as everyone’s different and it’s all about your comfort zones,” she says. “But you need liquidity available to cover extraordinary expenses such as a medical emergency.”
Menschik says the last thing investors want is to have to sell their investments to raise money during a down market. As we’ve seen recently, having spare cash is even more important if you have a loan that could be subject to margin calls.
So where should I stash this cash? If you have a mortgage with a redraw facility, putting the extra cash into your mortgage effectively allows you to “earn” the mortgage interest rate tax-free – as your savings reduce the interest payable on your loan. But if you want to build up cash savings, Orrock says the simplest option is to look at a high-yield savings account or term deposit.
“If you trust yourself, an online high-yield account can give you good interest with your money at-call,” he says. “But if you don’t trust yourself to leave it there, term deposits are offering attractive interest rates and you don’t have to lock your money away for long periods.”
Orrock says term deposit rates have risen as the banks have looked to increase their funding from deposits. Investors can now earn about 8 per cent on 180-day term deposits and even more if they lock their money away for a year.
He says innovations such as Suncorp’s term deposit product linked to its online savings account have made term deposits simpler and more flexible. With the Suncorp product, he says, you can nominate your term and get attractive interest rates.
Orrock says at-call online accounts are paying 7 to 8 per cent interest, typically with no minimum deposit. If you need to save to create your cash buffer, you can commit to regular savings through an automatic savings plan.
This story was found at: http://www.smh.com.au/articles/2008/03/17/1205602290166.html