The One Indisputable Rule Of Finance

There’s always talk about what’s right and what’s wrong in the world of finance. Even people who are complete numb skulls join in the conversation saying which investments they think are good or what economy is going to collapse or which nation’s leader is going to screw the planet. I have found myself in a position of having to persuade my clients of what I believed was the correct decision for them.

One Rule, No One Can Deny

There is one rule however where I refuse to bend. And luckily for me, this rule is appreciated as a standard rule across every generation, every country and the entire investor risk spectrum. It’s making sure that, no matter what, we have 3 months of income set aside.

Although the rule has been around forever, I feel it fair to say that most North Americans would have heard it first from The Wealthy Barber book. As much as I hate this guy, his head was definitely in the right spot with this one. For those of us who aren’t sure what I’m talking about, it’s quite simple: It’s having 3 months of income set aside, usually in a high interest savings account (or at least that’s what I tell my clients to do).

Why Have Three Months Of Income?

I use this rule for two reasons. The first and most recognizable is having the ability to deal with financial emergencies without using debt, or at the very least, curbing the impact of emergencies. Imagine your kid comes home and tells you he needs braces. Most stories of struggle to fight out of debt are usually caused by people who may have been good with debt, but faced an emergency that put them into huge amounts of it, making it difficult to come back. Having a lump of cash sitting around is huge in these types of situations.

The second reason for me is to make sure I can take advantage of great investment opportunities that come our way. Investment opportunities don’t necessarily mean hot stock tips. Imagine I told you I had season tickets to the Canucks for $200… That’s an amazing deal, but unless you had the money sitting around, you’re out of luck. Or imagine I owned a house in West Vancouver worth $4 million. It’s yours for $50k. Again an unbelievably, ridiculously amazing deal, but if you’re in a weak position financially because you’re so used to spending, unfortunately you’re out of luck, passing by opportunities to people who had the foresight to save.

How Can We Get There?

I remember watching a commercial for a mutual fund company where some guy that was being interviewed on the street said “banks make it too hard to save”. This is a load of crap. There are a few things to consider for sure, but it’s easy to do, thus giving people very little reason as to why they shouldn’t be able to do this.

The first thing to consider is your time horizon. Looking at how much you make, how soon do you want to have that lump sum of money built up? Don’t let your time horizon go beyond 3 years. Obviously, the sooner the better. The longer you go beyond 3 years, the more likely you’ll be spending the excess money at the end of the month. Also, when your time horizon is beyond 3 years, the amount of money you’ll have set aside each month is so low, you’ll be putting yourself in a very weak position.

The second thing to consider is the investment vehicle. The only investment you want to use for this is a high interest savings account from ING Direct* or wherever you can get the highest interest. The main reason being that you want to have easy access to the money, which is the whole point. There’s no point in having money to pay for an emergency if the money is put into an investment that takes 5 business days to get out.

The third thing you want to consider is the amount you actually want in there. I say 3 months but it goes without saying that the more, the better. The thing you want think about is that if you put a lot of money into an account that yields 1%, are you screwing future savings for your retirement? I usually recommend 6 months’ worth.

It’s A Great Position To Be In

Having this kind of savings set aside will immediately put you ahead of the vast majority of Canadians or any other country for that matter. It’s something that people just don’t do and yet, I suspect if I stood on a street corner and asked a thousand people if they thought that saving money was important, they would all say yes. Ask those same people if they were actually doing it, again I suspect that almost none would say yes. When it’s so simple, how else do you describe the lack of initiative besides “dumb”?

Just as a side note, when it comes to having money aside for investment opportunities, make sure you consider what you will get out of it in the end. You definitely don’t want to take money out for investment opportunities that will take longer than a few months to replenish. There is nothing worse than the feeling of paying for a vacation only to find out that your kid broke the neighbor’s window.

* Editor’s Note: Get a free $25 bonus when you open an ING Direct Canada account with $100 or more and enter Orange Key 16449274S1. It’s free money!