I’ll teach everyone how to set up your emergency funds using fixed deposits right here.
I know some of you veteran investors will already know all about FDs, but this one is for the newcomers.
You wouldn’t believe the number of inquiries I’ve had on FDs from readers. FDs are, by large the first form of investment everyone should have. They are a risk-free, interest generating financial product offered by the good banks here in Malaysia.
In this article, I’ll show you how to set up your Emergency Fund with FDs.
What are Fixed Deposits?
Fixed deposits or FDs as we will call them is, first of all, a financial instrument. Here in Malaysia, they’re provided by banks and gives a higher interest rate than a typical savings account.
The usual terms of a Fixed Deposit here in Malaysia:
1. You place a fixed sum with the bank for a fixed period of time.
2. The bank agrees to pay you a fixed interest rate.
3. You don’t touch that money. After the said period, you get your money back PLUS interest.
What if you were in an emergency you say?
And you needed to uplift the FD before it matures? Well, you’ll most likely lose all your interest. But your initial sum will NEVER be touched.
This right here is a liquidity problem with fixed deposits. Don’t worry I have a solution.
My Emergency Fund
An emergency fund is exactly what it sounds like. It’s a certain amount of money, easily accessible and put away in case of an emergency.
Exactly how much to put away? You’ll first need to know your average expenses and spending per month. After figuring that out, you’ll want at least a 6-month emergency fund.
Using myself as an example – On average, I spend around RM5,000 per month. All in.
So, a 6-month emergency fund would be RM30,000. But I try to keep a 24-month emergency fund going. Just cause. Which gives me around RM120,000 in liquid cash.
Now, the key ingredient for a good emergency fund is LIQUIDITY.
My emergency fund is 90% Fixed Deposits and 10% Savings Account and/or Cash. But an FD isn’t that liquid. So here’s how you make it liquid.
Why an Emergency Fund?
An emergency fund in my opinion serves two purposes.
The first one is to help you avoid a situation where you have to liquidate your investment assets in a crisis. As an investor, your portfolio can take a huge hit if you sell at the wrong time.
Imagine having to sell your stocks or that investment property due to a medical emergency.
The second reason is psychological. Knowing you have a safety net gives you a sense of security and peace of mind. It’ll give you a boost in confidence and has helped me as an investor focus on investing. I don’t have to worry about my expenses or my needs during an emergency.
I am genuinely positive that my emergency fund has helped me make better investing decisions.
Fixed Deposit Laddering
FD Laddering. This should address all the liquidity problems you have with your fixed deposits. Here’s how I do it.
Remember that RM120,000 emergency fund? It won’t make much sense if you put the whole chunk of it into one FD.
Say next month you needed to get your car fixed and it’ll cost you RM1,000. Uplifting that RM120,000 FD would mean you lose your interest. 3% on 120K is RM3,600 in interest per annum. That’s no chump change.
Solution? Break that RM120,000 up. I personally use Maybank so I’ll be giving you an example of it. The minimum FD placement is this – RM5,000 for 1 month.
My FD Ladder
If you’re up for it, you can go right ahead and break them up into 24 tiny chunks.
I differentiated mine into RM10K and RM20K FDs, with a mixture of 1-month and 3-month periods. It’ll look something like this:
The longer you place your money in an FD, the higher the interest the bank pays you. It is, however, a negligible difference because you’ll be compounding your money if its a monthly one anyway.
Also, try to make sure you place your FDs on different days of the month. I have them in the beginning, the middle and the end of the month. This will allow you to eventually uplift the one that’ll cost you the least in interest in the event of an emergency.
Fixed Deposit Perpetuity
I always select the following 2 options whenever I place an FD.
1. Credit interest earned to the principal.
This essentially means you’re compounding your interest automatically.
2. Renew FD at maturity.
This means I never have to look at my FD Ladder again. It’ll run by itself.
I know most of these are common sense to some, but I still hope I managed to bring value to everyone reading this.
I’m sure some of you have more sophisticated FD hacks and tricks. Please, do share!
For the next article of the FI/RE and Savings Series, check out article 005 – The Seven Stages of Financial Independence.