April

Emergency Funds & Optimism Bias for April – Financial Literacy Month:

Introduction

April is financial literacy month; a time when we can organize our finances and plan for the year ahead. Why is this important – you may ask. Well, a study by Bankrate found that 28% of Americans have no emergency savings, often due to underestimating the likelihood of needing them. In Singapore, optimism bias is evident in how only 44% of households have at least 6 months’ worth of expenses saved, despite advice from financial experts to maintain such a buffer.

What is Optimism Bias?

Optimism bias is the tendency for individuals to believe that they are less likely than others to experience negative events. This cognitive bias leads people to underestimate the likelihood of encountering financial emergencies and, as a result, they may not save adequately. This month focuses on the importance of maintaining emergency funds as well as careful financial planning. Imagine you are caught in a thunderstorm with no way home. In this case, your umbrella may occur resulting in insufficient emergency funds. People with an optimism bias often assume that they will not face emergencies like job loss, medical expenses, or unexpected repairs, leading to a lack of preparedness in the form of insufficient emergency savings.

Case Study:

Singapore Scenario

In Singapore, optimism bias is commonly seen among entrepreneurs and property investors. Many new business owners are overly optimistic about their venture’s success, leading to under-preparation for financial setbacks. Local Example: The 2018 warning from MAS highlighted that nearly 50% of new businesses in Singapore fail within the first five years, partly due to optimism bias leading to inadequate emergency funding.Property Market Insight: During the early 2010s property boom, optimism bias led many to over-leverage in real estate investments, underestimating the risks of a market downturn.

Key Takeaway: By acknowledging this bias and prioritizing the establishment of a comprehensive emergency fund, Singaporeans can better navigate the challenges of business ventures and property investments, reducing the risk of financial strain during unexpected downturns.

Risk Management Strategies

Practical Tips:

  • Recognizing the Bias: Acknowledge that optimism bias can cloud judgment and lead to insufficient preparation. Regularly assess your financial situation with a critical eye, considering potential risks and worst-case scenarios.
  • Actionable Advice:
    • Establish an Emergency Fund: Aim to save at least 3-6 months of living expenses in a readily accessible account. Automate savings to ensure consistency.
    • Reevaluate Regularly: Review your emergency fund periodically, especially after major life changes like a job switch or starting a business, to ensure it remains adequate.

Case Study:

  • Example: Mr. Lim, a 35-year-old Singaporean entrepreneur, initially underfunded his emergency savings due to optimism about his startup’s success. After facing unexpected legal and operational challenges, he realized the need for a more substantial financial buffer. By prioritizing the growth of his emergency fund, Mr. Lim was able to navigate the challenges without incurring significant debt.
  • Tools & Strategies:
    • Use Budgeting Apps: Tools like Seedly can help track expenses and identify areas where you can save more for your emergency fund.
    • Financial Planning: Engage with financial planners to stress-test your financial plan against various scenarios, ensuring that you’re prepared for potential setbacks.
  • Implementing Strategies:
    • Step-by-Step Guidance:
      • Start Small, Build Gradually: Begin by setting aside a small percentage of your income each month. Gradually increase this amount as you get more comfortable with your budget.
      • Prioritize Regular Contributions: Make emergency fund contributions a non-negotiable part of your monthly financial routine, just like paying bills.

Additional Resources