We are living through interesting times, one could say historical times….but one of the many things that remain constant, despite that we can all feel that things have changed so drastically is our finances and making sure that we have a financial strategy in place to look after not only ourselves, but our family.
One of the most crucial elements to any financial strategy is cash management – how do you manage your cash on a daily, weekly, monthly and even yearly basis to make sure you can weather any crisis.
There are three main elements to this, which I recommend to all clients, regardless of whether they are business owners or employees and regardless of what they earn, as let’s face it – most people spend what is in their bank account – regardless of what they earn.
It comes down to having three accounts, let’s call them ‘buckets’ in your cash management strategy:
- Transaction account
- Savings (emergency) account
- Investment account
Most people have more than one of each account, which is really not necessary and just complicates matters.
Let’s go through each in turn….
This is the basic account – the one we are all used to. All income should be paid into this account, and all ‘regular’ expenses should be paid out of this account. The benefit of having just the one account for all expenses is that it makes it easier to track spending – especially with so many banks offering apps that let you track your spending, should you wish.
Another benefit is that it also makes it very clear in terms of what can be spent each month – you should only be spending what is in this bank account – and if you have to dip into the savings account, it is a clear sign that you are spending more than you are earning.
I do not believe in budgeting – no one likes to feel restricted – especially when we are feeling enough restriction in our lives – so a simple cash management strategy is to simplify and consolidate your transaction accounts into one, and manage your spending by watching the balance in your transaction account.
Think of this account as your safety buffer, or your emergency account. This is the account that you should only be dipping into in case of emergency – if the car breaks down, if there is a family emergency, or if due to a crisis like Covid-19 and your income reduces, you know you have back up savings that you can draw on.
The amount that you should keep in your savings account will depend on your personal situation and your ‘sleep at night’ factor. How much do you need to have in a bank account with immediate access and know that you can sleep at night, knowing that you and your family will be ok in an emergency. Two factors that will affect this amount will include:
- How reliable is your income? The more reliable it is, the less you need to have as a safety buffer. The less reliable – such as being affected by Covid-19 and the more you should have in the account.
- Do you need to provide for a family? If you are single, you do not need as much cash, but the bigger the family, the more you might need in case of emergency in case something happens to any one of them.
These factors can determine how much you should keep in a savings account, and there is no ‘right’ amount to have in a savings account. It is a very personal decision, based on your circumstances and comfort level.
Once you have enough in a savings account that you feel comfortable with – then you can start to think about investing.
The bank accounts are there to provide for your short term needs, but an investment account is to provide you with wealth in the longer term, but you should only be investing after you have enough in your savings account and you are unlikely to need the money in the next couple of years – this gives the investment time to grow, which is what it is designed to do, but it does need time.
Think of your savings account as providing short term security and your investment account providing long term security – it is your investment account that will provide you with financial security, independence and choice in the future – but it only works when you have enough short term security to deal with crises that do occur from time to time.
Regular savings plans work well with investment accounts – adding a regular amount to your investment account and let it build up over time – regardless of the swings of markets – and if anything, taking advantage of falls in markets. This should be set up as a direct debit from your transaction account – so you don’t even need to think about it. In an ideal world, we would recommend saving 20% of your after tax income, but any amount that you can save is a start and sets you on the right path.
If you need to dip into your savings account, you just adjust your regular savings amount back to the savings account until it is at the balance that you are comfortable with – and then re-direct back to the investment account. It is always important to make sure that your savings account is at the ideal balance before continuing to add to your investment account.
Especially as we continue to experience uncertain times, it is more important than ever that you have your cash management strategy in place with both your transactions and savings accounts in place, before you start investing.