Suppose your favorite car is a Honda… which is worth Rs 10 Lacs. And in your city, there is only one Honda dealer. Now this Honda dealer is facing some unprecedented personal crisis and decides to close down his dealership. And since he wants to close down quickly, he wants to clear his stock of available, unsold cars at throwaway prices. In fact, he is offering a whopping 40% discount on your favorite model, if purchased within next 7 days.
So here you are faced with an interesting situation…
– You always wanted that Honda car. And you have absolutely no doubt about the brand or quality of the car.
– You did not have (or want to pay) Rs 10 lacs for the same.
– You are now getting it 40% cheaper at Rs 6 Lacs.
– You have 7 days to buy it.
– You are still 100% sure about quality, efficiency and beauty of the car and that, it has not deteriorated at all (with prices coming down to Rs 6 Lacs)
So what is that you want the most right now?
Of course…Rs 6 Lacs!!
But here is the problem. You don’t have Rs 6 Lacs. And your 7 days are over. The offer and your dream Honda car are gone.
You had the CRISIS (dealer was closing down) and the COURAGE (your belief that Honda remains good enough even if dealer closes down). But the only thing missing was the CASH.
You did not have the CASH to take advantage of the opportunity.
The same is applicable in stock markets as well.
Warren Buffett, in 2008 said:
“CASH combined with COURAGE in a CRISIS is priceless.”
With markets making new highs and being somewhat Overvalued, many people will laugh at those who are building up their cash reserves. And that is because of the perception that, it’s very easy to make money in markets and hence it does not make sense to remain in cash.
Yet CASH is the exact asset, which can help you buy wonderful businesses at really cheap prices (Remember 2009). Having a decent amount of cash (atleast when markets are not cheap) allows you to take advantage of any pullback in the market or any other opportunity that comes up. Holding Cash should be viewed as an opportunity, and not just as a cost. Now this strategy effectively means that you are ready to purposefully lose a small amount of money to inflation over this period. But that would be in exchange for the opportunity to offset it with a larger profit down the road. Now all investors may not have the mindset to endure this pain, caused by waiting for opportunity to strike. But for those who are patient enough, the gains can be, what Warren Buffet said – PRICELESS.
Also if you think that earning lower interest on your cash is bad and a drag on your portfolio, just wait until you are forced to liquidate stocks during the next bear market or in time of need.
Pardon me if all this makes me sound like a person advocating timing of markets. But this is not just about market timing. It’s more importantly about trying to avoid overvalued markets and trying to reduce the chances of making mistakes, and less about trying to find the bottom and pick the next multibaggers.
So if you think, I am making some sense here…then do bookmark this post for future reference. My idea of doing this post about market crisis during a bull run is simple. When markets around you are falling and you are losing your money, you will not be reading blogs about long term investing. 🙂
A lady reader (Aarti) asked a genuine question in the newly created Contact section of Stable Investor. “I don’t understand stock markets, but wait eagerly to read other articles on your website. Everywhere on your site, you advocate that one should make an Emergency Fund. As a novice, how should I start making this emergency fund?
I feel its very tough for me to save money. And every month end, I am almost broke. Please help.” In this post, I would try to help the lady create an Emergency Fund in 5 easy steps.
Emergency Fund, as the name suggests is there to handle emergencies. A job loss, illness, accidents, etc. An emergency fund should have sufficient funds to cover your expenses in case you loose your job, meet with an accident or have some unplanned expenditures?
Remember God in good times and Emergency Funds in bad times
You can take following approach to create your own emergency fund –
Step 1: Calculate your total monthly expenses
This is the first step and you should not get this one wrong. When calculating expenses, it is necessary to calculate your family’s expenses and not just your own. This should include everything from expenditure related to food, rent, loan repayments (EMIs), transportation (fuel) costs, monthly insurance premiums, monthly investments (SIPs in mutual funds), medicines, telephone bills, electricity & water bills to more discrete expenditures like eating outs, gifts, festivals etc.
Step 2: Decide how much you would like to save
This totally depends on your level of comfort. There are different opinions about how much money you should put in an emergency fund: 3 months, 6 months or 12 months worth of expenditures. But don’t worry about others. Its your emergency fund and only opinion which matters is yours. Ask yourself how much you would need to feel secure, and make that your target for an emergency fund.
Step 3: Open an account
Once you have decided how much you need to put in your emergency fund, it is time to decide where to keep your money. One major requirement of emergency funds is liquidity. This means that you cannot park your money in mutual funds, stock markets, gold or other illiquid assets. The best option would be to open a Savings Account. You should open an account exclusively for this emergency fund. Or otherwise, you would be tempted to dig into your emergency fund account for non-emergency requirements. Though saving accounts don’t offer much as interest, it is important to understand that what they do offer is ‘liquidity’. Some banks offer close to 6-7% on Savings Account, which is quite decent considering the liquidity these savings account offers.
Step 4: Determine how much you can save regularly
Emergency funds aren’t built in a day. It takes time and regular savings on your part. Analyze your finances and determine how much you can afford to put towards your emergency fund every month. Don’t worry if you start small. Even a small amount will do as when you start saving, you realize the importance of such a fund and the risk of not having such a fund.
Step 5: Automate it
If possible, make arrangements to allow automatic transfer of funds to this emergency account. This can be done on a pre-selected date every month. This is advisable as it brings discipline in saving and also prevents you from making any rash expenditure as you would always have the thought of automatic-emergency-fund transfer at the back of your mind. 🙂 And it is my personal experience that if you don’t have to think about it, savings are much easier.
Dead Monk’s Advice: Don’t risk your emergency fund by going after higher returns.
Many of your ‘well-wishers’ and so called financial experts will tell you that you can easily earn more than 7% if you are ready to invest in MFs, stocks etc. But beware. Do not listen to them. Why? Read the following scenario…
A little common sense would tell you that one should not take risks with emergency funds. Suppose you invest you emergency fund in stock markets. During recession, you lose your job. It is common knowledge that during recession (when you lose your job), the markets would be down, i.e. your investment would be quoting at prices lower than your purchase price. Hence, you would have to book loses in case you want to use your emergency fund. This would not have happened if you had stuck to safer savings bank account.
As of now, you might feel that you are not in some kind of emergency situation…
Suppose you earn Rs 50,000 every month. Your monthly expenditures are Rs 25,000. You want to build an Emergency Fund of 6 months, i.e. (6 Months x Rs 25,000 = Rs 1,50,000). Assuming, you are able to put away Rs 10,000 every month, it would take you 15 months to create an adequate emergency fund.
Timeline for creating an Emergency Fund – (Click To Enlarge)
So start now as 15 months is a long time and you would not like to face an emergency without having a fund to handle it, isn’t it?