Ready the Warchest: Prepare for Your First investment (3 of 4)
I’m sure many of you are already building up your emergency fund as we speak (or write). So it is time to jump into the third step of preparing for your first investment.
R = Ready the Warchest
A “Warchest” is any amount of money that you set aside for future investments. Frankly, I don’t know of many people who keeps a Warchest in their personal finance planning (except the other investment bloggers that I follow), let alone regularly contributing to the Warchest.
Why Do I Need a Warchest?
Simple! So you are able to snap up any great deals that the market offers. Imagine, one day if the shares of DBS Bank are selling for $0.50 each, you will definitely scope up as much as possible right? But like any normal human out there, we still have to pay for other expenses such as mortgage, car loan, food, bills and whisky (Remember Step 1?). It will be quite hard for us to suddenly fork out a huge sum of cash to take advantage of this offer! Therefore, it is important to have a Warchest ready at all times!
Saving Requires a Strong Willpower
While you don’t have to save up a lot each month for your Warchest, you need to be consistent about it. And this is the hardest step of all as it requires something that is in short supply – Willpower
I have heard many spoke about saving for investment and it often goes like this,
“No problem, I will save whatever I have left after spending. I don’t spend that much”.
But when I ask: “How much do you regularly save and when will you reach your targeted amount for investment?”
Often the replies are less assuring: “Hmm, I’m not sure, maybe $200?” or “I think I will reach the target by this year”
However, I do not blame them because our education system has never taught us about saving, or rather how to go about saving. It is often taught as: “Tom has $5, and he spent $3 on apples. How much will Tom save?”. While most will answer: “$2”, my answer is: “Most likely nothing because Tom will buy other stuff!” And this is very serious. We often overestimated our willpower in resisting the temptation to spend. We believe we will somehow keep a mental note at all the time to save a specific amount of cash when we are spending the rest. We need to recognise that most of us (I’m guilty too) have a tendency to spend what we have available to us. Willpower is over-rated!
How to Build Your Warchest?
Do you remember the first two steps that we went through?
- Budget your finances – You have ensured that you are spending less than your income, and have some savings at the end of each month
- Insure against the unexpected – You have put aside some cash each month towards your emergency fund
Now the third step is take the positive savings minus the emergency cash. This will be your monthly savings into your investment fund!
By combining Step 1 to 3, you are able to accumulate cash for investment while meeting your expenses and building an emergency fund. Therefore, I would recommend that you create 3 separate accounts. One for each purpose.
Current Account: This is where your monthly salary is credited to. It’s to be used for expenses.
Emergency Fund Account: Before you invest your emergency fund, this is the holding account to accumulate the fund first.
Warchest Account: This is where you save up regularly for your future investment.
I would recommend that you save monthly into your warchest before you start spending. That means when your salary is credited to your Current Account, immediately transfer the required amount into your Warchest Account. Yes, you need to protect your Warchest from yourself. In this case, you removed the need to have a strong willpower and created a very disciplined way of building your Warchest.
Pro Tip: You can automate the process by creating a standing order in your Current Account which will automatically transfer the specific amount in the Warchest Account on the day of your salary is credited.
What If I Can’t Save Much for Warchest
Go back to Step 1: Budget Your Expenses. This could indicate that your expenses are too high. You need to review your Lifestyle Expenses again and see how can you reduce it. Or perhaps you have wrongly categorised some expenses as Essential Expenses, so go back and do it again. Be honest about it!
Pro Tip: Only spend from your Current Account. In that case, you can avoid using your Warchest when your expenses are high. The balance in the Current Account tells you how much more you can spend. That’s disciplined spending!
The Power of a Warchest
$200-$300 each month may seem too little for any form of investment but it is a great way to gradually build up your Warchest. When you are consistent about it, your Warchest can grow to a sizeable sum, be ready for “war” when a great investing opportunity arises.
Let’s assume you save $200 into your Warchest each month since 1990. But you are unsure about investing hence you did not invest until the 2008 economic crisis.
You saw that STI crashed so much and it presented an investing opportunity! So you happily deployed your Warchest and invested in the Singapore’s Straits Times Index (STI). Not knowing the market well enough, you decided to follow the conventional wisdom of buy and hold until Jan 2016. To save you trouble, I did the math below
- $200 x 12 months x 16 years = $38,400
- You invested in STI at $1.88 per unit in Dec 2008
- You bought ~20,400 units of STI
- You sold your units of STI at $2.60 per unit in Jan 2016
- You received $2.60 x 20,400= $53,040 and your Warchest gained ~$15,300 (38% of your original investment)
Yes, you achieved 38% gain from your original investment by investing in an index of a small country and forgetting it for 16 years! During these 16 years, you were working, earning more income, spending precious time with your family, while the Warchest generated $15,300 of passive income.
You Don’t Need to Be Professional Investor to Invest
Now, I just want to highlight another amazing fact here. You achieved 38% gain despite being an average investor! Here’s why:
- While you bought STI at $1.88 per unit, the market actually deteriorated further in 2009 and STI went as low as $1.52 per unit in early 2009. But you were sleeping so you didn’t notice.
- Still sleeping, you missed the opportunity to sell your units of STI before the China’s Black Monday in 2015 and the China Circuit Breakers Saga in 2016. The STI was once at a high of $3.52 per unit in Apr 2015.
So despite being an average investor, you managed to gain a respected 38% gain in your investment over a period of 16 years. In fact, you would have beaten many actively managed funds in the world. Imagine how great your returns would be if you have more cash in hand and invested when the market deteriorated further in 2009?
Now, we have completed Step 3: Ready Your Warchest. With your Warchest up and running, next week we will proceed to the final step of preparing for your first investment.
You are almost ready! Are you excited? I’m excited!
I hope you enjoyed this post as much as I enjoyed writing it! Leave a comment below if you have any questions and difficulties in creating your Warchest. I would love to help. Otherwise, just introduce yourself and say hi!
Next week, we will go into the final step of preparing for your first investment.
See you next week!
Investing Always,
Pete