If you have clicked on this title and reached this article, it is likely you do not have an Emergency Fund in place yet and are keen to know what it is and how to create it. If yes, you are one of millions in India who perhaps didn’t feel the need for, or perhaps never had the circumstances for having an Emergency Fund.
But hey, do you know that creating an Emergency Fund is the FIRST thing to do when you make a personal financial plan? The absolute first. Everything else, your insurance, your savings, your loans, your deposits, even planning for your child’s education and your retirement come much later. Fairly obvious why. Because an emergency can happen ANYTIME. Even as you are reading this article! Are you still thinking that if you need urgent money, you will take it through a (high-interest) loan? That’s not smart at all.
What Emergency are we talking about?
A situation wherein there is a family emergency, or a job loss, or an accident, a sudden large expense, etc. We hope these never happen to you but you will agree that sometimes all the laws of probability can conspire against you in one go! 🙁
What is an Emergency Fund?
Simple. An Emergency Fund is an amount of money that…
(1) will take care of your and your family essential expenses for at least 9 months,
(2) is in liquid form (cash or in a savings account of a bank from where you can withdraw instantly),
(3) should be a low or no risk investment.
Remember that you cannot sell a property if you need money in a hurry. The guaranteed, easily accessible Emergency Fund can help you tide over a loss of job for the period till you find the next one, or handle a sudden medical emergency, or allow you to loan it to someone dear who badly needs it.
How to build an Emergency Fund?
Let’s do this with an example. Say your net monthly income is Rs. 60,000 and your total expenses in a month are Rs. 40,000.
1. First, know your essential monthly expenses. Only the important ones like loan re-payments, groceries, school fees, monthly building maintenance, conveyance, etc. should be considered. Ignore the frivolous or optional ones like entertainment, party expenses, gifting expenses, etc. Let’s say that essential monthly expense amount is Rs. 30,000 per month.
2. Decide where you want to keep your emergency fund. We recommend 3 options, in priority. First preference, a Liquid Mutual Fund, which can offer you both liquidity as well as a better tax-efficient return compared to a bank deposit. If you are not comfortable with Mutual Funds, go for a regular savings account or a breakable Fixed Deposit. These days you also have SB accounts that offer higher interest rate of 6% to 7%. Last option, cash. Very liquid, but risky to handle and store. Most importantly, cash in the house ends up getting SPENT! 🙂 Avoid it. You can anyways withdraw money from the nearest ATM 24×7!
Of course, you could also choose a combination of these options. But try to keep most of them in the higher priority options we just mentioned, provided you are comfortable with those options.
3. Now the most important step – creating the Emergency Fund. You need to have 9 times your essential monthly expenses as your Emergency Fund. In the example here, Rs. 2,70,000. Looking too high? Ok. Then decide how much you want to start with. Say let’s start with say, Rs. 50,000. Build it up slowly with every month, e.g. add Rs. 20,000 you save every month to it so that in the next 11 months, you have added another Rs. 2,20,000 to the Rs. 50,000 you started of with, adding up to Rs. 2,70,000. You have reached the level of at least 9 months of essential expenses – your Emergency Fund is ready! 🙂
Key Considerations for your Emergency Fund
1. Especially for those who like to invest in Equity yielding about 12% returns annually, the Emergency Fund earning you just 5%-6% is NOT a waste. You will know its worth if you were to really need it one day.
2. The Emergency Fund is ONLY for emergencies. So if you feel the urge to buy that latest smartphone, DON’T use the emergency fund, use some other savings and if you don’t have that, create one and buy the phone only when that is done!
3. When there is indeed an Emergency, don’t use you Credit Card. Instead USE the Emergency Fund – that is what it was meant for.
So when it comes to be really needed, this small Emergency Fund can create a big difference!
Having now understood the importance of the Emergency Fund, you have taken a big leap in your financial life. Go ahead and create that fund. And once you do it, sleep well.