Financial planning: How to allocate your cash more effectively

Cash management, though often overlooked, is an essential part of your financial plan. To manage your cash effectively, not only do you need to know how much cash to set aside for your various financial goals but also where to put that money.

A recent report found that a third of UAE companies would not be increasing existing salaries throughout 2021. With this in mind, now couldn’t be a more prominent time for you to really consider allocating and growing your existing cash flow, ultimately making it work far harder for you.

We help break down how to place the optimal amount of cash in all the right places, so one can really reap the rewards without a salary increase.

How much cash should be in your current account
You should only use your current account to hold enough cash to cover your monthly expenses for the next one to two months. Current accounts earn negligible interest and anything more than what you’re spending in the short term is actually decreasing in value because of inflation.

Plan ahead by assessing how much you’ll need for your bills (for instance, rent, utilities, and phone bills), and purchases you foresee (for example, meals or a staycation you’re taking this month) and make sure you have enough for that one to two months in your current account. You can add a little buffer if you’re uncomfortable with the small amount in your current account but keep in mind that the bigger the buffer, the more likely you’ll be tempted to overspend. The size of your buffer comes down to how disciplined you can be versus how risk-averse you are.

Money you’re not spending in the next one to two months can be put to much better use in an interest-accruing account or investments so that you can reach your financial objectives.

Emergency funds should be interest-accruing accounts
Your emergency fund’s value should at least keep up with inflation, so it shouldn’t be in a current account. Because you don’t tap into the emergency fund often, it has time to grow so that it doesn’t lose value to inflation.

Keep your emergency fund in a liquid, interest-earning account instead of a current account. This can be a savings account, money market fund, or other low-risk, liquid investments.

Evaluate the interest rates when you’re deciding where to put your emergency funds. Banks advertise attractive interest rates, but in reality, only a portion of your balance is eligible for the advertised rate, and often only for a specific period of time. For instance, if your emergency fund of Dhs100,000 is in your savings account, it’s likely that the entire amount isn’t earning the stated rate; instead, your funds are subjected to a tiered earnings rate.

With tiered interest savings account, you earn small interest increments with each dirham you have, up to a certain balance threshold. So, if a bank offers, say, 0.5 per cent , you most likely aren’t earning 0.5 per cent on the full Dhs100,000 — maybe you’re earning 0.5 per cent on Dhs25,000 of it, and then a lower interest rate on the rest. Make sure to always pay attention to the fine print.

The key with the emergency fund is to have liquidity you can access whenever life throws you a curveball. Fixed deposit accounts aren’t good options for your emergency fund because you’d have to pay a penalty for withdrawing your money before it reaches maturity.

Alternatively, you can keep your emergency fund in a low-risk liquid investment. To ensure that you don’t compromise your long-term financial goals, make sure that you have enough emergency funds that are liquid so that you don’t have to dip into your medium to long-term investments when you’re faced with an emergency.

Ideally, your emergency fund should cover at least six months’ worth of expenses.

Set aside money in short-term investments for upcoming expenditures
The last thing you want before making huge short-term financial decisions, such as a home down payment or paying for your wedding, is for the money to drop in value because of a market dip. But money set aside for upcoming expenditures also shouldn’t be kept in cash either.

Instead, you can have short-term investments (zero to three years) in low-risk products that earn a return. So, don’t put your down payment in a current account until you’re ready to use it but also, don’t keep it in a risky portfolio either.

Liquidity and low volatility are critical when it comes to short-term investments. Make sure that whatever vehicle you select that you can easily access your money when you need it.

Invest the rest of your money
Let the rest of your money work even harder for you. To reach your medium to long-term goals, take advantage of compounding interest and let your money grow exponentially over the long time horizon.

If you unnecessarily keep too much of your money in cash, you’re missing out on potential returns that could help you reach your financial objectives sooner. If there’s cash that you aren’t planning to use in the next few years and isn’t part of your emergency fund, it should be invested.

Ramzi Khleif is the general manager for StashAway MENA