What is Emergency Fund and How to Build It?

What is an Emergency fund?

Emergency fund is a corpus of money which is been kept aside to face any unexpected event in the future. The events could be sudden decrease in income, sudden financial liability, temporary income stop due to temporary disability or job loss.

Emergency Fund

Emergency fund is one of the Must Do Activity for all individuals

Before starting investing prepair Emergency fund. But most of the time we forget to plan and as well as to implement it. One should give importance to the Emergency Fund as it is a first step of Financial Planning. This Emergency fund should be in very liquid form so that it is instantly accessible with in no time.

  • What should be the size of Emergency fund?

  1. Thumb rule is that one should have at least 12 months of his monthly expenses plus going on EMIs as his/her Emergency Fund.
  2. But if the investor has a stable job, good savings and controlled expenses he can set aside 6 months of his monthly expenses plus going on EMIs.
  3. If your spouse is working and you consider that job can cushion you in any shortfall of your income then 3 months of his monthly expenses plus going on EMIs. is sufficient as emergency fund.
For Example :
Suppose Varun is in IT firm earning handsome salary, and he can save up to 40 % of his salary then he can save 12 months of his monthly expenses as Emergency fund. In this case let us assume Varun’s monthly expenses is 60000 and home EMI is 30000 then he should have 12 months expenses+home EMI as his emergency kitty i.e. 10,80,000 Rs. 

Emergency Fund and Investment should not be mixed at any cost. Never consider the money kept aside as emergency fund as your investment. You should not map it with any of your goal. One should always update your Emergency fund to tie whenever your expenses increases.

Where to park your Emergency fund?

Most important aspect of the emergency fund is, it should be easily accessible at the time of emergency. Liquidity is the highest criteria. Second one could be Capital Protection. Whatever money we are keeping aside should be safe at all time. Third one is this money can earn reasonable return.

Following are the most preferred Financial Products used for Emergency Fund.
  1. Cash - Many people keep cash at home for emergency. This is an age old style of households. But it carries risk of theft, and most importantly decreasing its value over time due to inflation. Keep cash only for your usual expenses not more than that. And now a days every thing can be purchased through online payment platform like Payphone, Google pay, Paytm etc. so no need of lots of money at home.
  2. Bank saving account - This is another option for many investors. Here possibility of theft is taken care but what about returns on saved amount? If the inflation is considered as 5% then your amount in bank saving account will yield you only 3 to 4%. This means your value of money is decreasing
  3. Bank Fixed Deposit - This s one of the recommended option for Emergency fund. You can park your amount here which provides liquidity, safety and as well as higher return as compared to bank saving account. But FDs still not suitable for the highest bracket tax payers. Its post tax return drastically decreases for 30% Tax bracket investors.
  4. Recurring deposits - RDs in bank or post offices can be a recommended option for Emergency fund Ceartion. If you don't have sizable amount to do as FD you can start RD for one year and after its maturity convert it in FD. Again start RD for a year and convert it to FD. You can do it until you accumulate the targeted amount.
  5. Liquid Funds - This is the most suitable option for any investor preferably to the highest tax bracket investor. Liquid funds are simply debt mutual funds that invest your money in very short-term market instruments such as treasury bills, government securities and call money that hold the least amount of risk. The rate of return of liquid fund is always better than FD and RD. One can withdraw the amount instantly too.
  6. Credit card limit - Modern investor consider credit card limit as their Emergency Fund. If you have good credit history and uses credit card extensively bank offers huge credit limits. In case of emergency you can just swap the card and get it solved. This is not a recommended option by me as if you are not able to pay the credit card amount you have to pay hefty interest on it and you can get trapped in new debt.

  • Before starting investing do these 3 things

  1. Set aside 6 to 12 months expenses including EMIs as an emergency fund in liquid funds, bank FD or bank RD. Always keep it updated as your expenses increases. And Consider Emergency fund as your expense, not your Investment.
  2. Buy online term insurance plan with maximum cover possible till you retire or you have dependents. Buy disability rider and accident benefit raider of equal sum assured along with the term plan or separately.
  3. Go for standalone (for you and spouse) or family floater health insurance plan as your base plan and buy a top up health plan apart from the one your employer provides. This arrangement will save your premium outgo.
If you have not prepared any emergency fund yet then start it today

Comments

  1. Very informative post regarding financial percepectives.

    ReplyDelete
  2. Good concept. We should be prepared for emergency. You are doing great job as many people don't have any idea about basic things. Keep it up.

    ReplyDelete
  3. Very Good Information Covered in this Post related to Financial Planning.

    ReplyDelete

Post a Comment

Popular posts from this blog

Post Office Investments for Small and Safe Investors In India

Which is better Investment plan PPF or VPF?

Best Ways To Save Money

What is Investment ?

Pradhan Mantri Vaya Vandana Yojana

LIC Jeevan Shanti - Shanti For Life Time

Public Provident Fund