EMERGENCY FUND IS THE PILLAR OF A STRONG FINANCIAL PLAN
We live in an era where joint family is an endangered species and thus you are left to fend for yourself even in an emergency financial situation.
In a Contingency Situation, the options for you could vary from selling your prized processions to selling your blue chip shares/Mutual funds to taking a Credit Card loan or even borrowing from your friend or the next-door moneylender.
All these could lead to potentially rock your Financial Plan. This is where an EMERGENCY FUND comes into the picture. One of the biggest lessons that COVID has given all of us is the importance of having an EMERGENCY FUND
Emergency Fund acts as a Shock Absorber of a Financial Plan. The absence of it can make a Financial Plan turbulent. Once you have this covered…. then the mental peace you have is unparalleled.
If you don’t have an Emergency Fund, SET IT UP NOW!!!
WHAT ARE THESE EMERGENCIES????
Upgrading from a Maruti 800 to a Mercedes Benz is NOT an Emergency!!!
Medical contingencies, job loss, and salary cuts are some emergencies that you must be prepared for.
A sudden Medical Complication in the family fits in as the best example of an Emergency.
True, Health Insurance will be there and should cover the bill, but Mediclaim does NOT cover everything and sometimes, during a medical emergency, not many will have neither the patience or the time to go through the procedure of following up with the health insurance companies.
Job losses have become a common part of our daily life. Losing your job without a notice period is another case of an emergency.
Even a Sudden House Repair (due to Earthquake or a Huge Rainfall following Water creeping into your home and damaging interiors) too comes under the category of Contingency.
So, at the cost of sounding repetitive, let me reiterate, Any Unforeseen Expense which can upset your Financial Plan is a fit case for linking to a Contingency Fund.
And even replacing your SMARTPHONE (due to sudden breakdown/repair) is also an EMERGENCY in this age!!
HOW TO SET UP AN EMERGENCY FUND:
To set up an emergency fund, you need to create an Emergency BUDGET based on your living expenses.
1. Start with the MOST important expenses like Food, Medical costs, Rent, EMI, Groceries, etc which are uncompromisable. And gradually scale up.
2. Multiply these expenses by a minimum 3 times (for e months) so that you get an idea of HOW much to keep.
3. Divide this money into different SAFE, LIQUID baskets such that is most easily accessible when needed.
4. Give your Emergency Fund contribution the highest priority
5. Review and adjust as necessary.
HOW MUCH SHOULD I KEEP IN THIS EMERGENCY FUND:
3 to 6 months of EXPENSES (not income) is to be kept aside as an Emergency Fund.
Of course, this will vary depending on personal circumstances, such as job stability, income level, family size, and other factors that impact financial security.
Having a stable secure job means 3 months of expenses is enough.
But if your income is commission based or where the inflow is volatile, it makes sense to keep a larger amount in the emergency fund.
However, having a target range of emergency funds is a good starting point.
WHERE DO I KEEP MY ALLOCATION FOR THIS EMERGENCY FUND:
Emergency funds should be kept in Low risk, liquid assets that are most easily accessible whenever needed.
High-Yielding Savings Account
Overnight & Liquid Mutual Funds
Even Cash at home (some part)
It seems stupid to lock away 6 months of Expenses in that lowly Liquid fund when your friend is minting money in Day Trading.
Some investors do keep a portion of their emergency fund amount in
All these are good short-term options but not ideal for emergency funds as these are liquid enough to come into the emergency fund option basket.
The primary purpose of a Contingency Fund is the Preservation of Capital and returns should be treated as Bonus, nothing else!
I would recommend that you split your Contingency Fund into
30% in SB Account
30% in Flexi Deposits
30% in Liquid/Overnight Mutual Funds
10% in Arbitrage Fund (yes, I know, I am creating a bit of controversy here.......).
Why Arbitrage Fund?
Yes, it is quite unlikely that you will be using your entire 6 months of Contingency fund in one go.
And, even if yes, the Contingency could be either 1 month away or even 10 years away (or if you are very lucky), could never happen!
And emergencies come in all forms and there are some kind of emergencies that allows you the luxury of arranging funds after a few days.
But do remember, having a Contingency Fund, is purely for a Contingency and if you are earning anything out it, it should be treated as a Bonus only!
And, please, for God's sake DO NOT CONSIDER YOUR CREDIT CARD AS YOUR CONTINGENCY FUND!!!
Emergency Fund also includes a RAINY-DAY fund!
Now...what is this Rainy-Day fund?
The Rainy Day fund is for expenses that occur annually (or bi-annually) but occurs at unexpected times.
For example, Car Repair is an expense that can occur ANY TIME.
It’s not an EMERGENCY expense but not an ignorable one.
For this type of Expense, you can use a fund called RAINY DAY
Many investors keep the Rainy-Day Expense Fund as a part of Emergency Fund itself and it's perfectly all right to do so.
It's important to keep emergency funds separate from other investments and savings, as they serve different purposes and require different criteria for allocation and management. By keeping emergency funds separate, we can avoid the temptation to dip into them for non-emergency expenses or investments.
IF YOU ARE STARTING FROM SCRATCH AND DO NOT HAVE AN EMERGENCY FUND... YOU CAN GRADUALLY START BUILDING THE SAME.
NO NEED TO RUSH THROUGH. TRANSFER A FIXED AMOUNT CONTINUOUSLY TILL THE EMERGENCY CORPUS BECOMES ABOUT 3 MONTHS OF EXPENSES
EMERGENCY FUND ACTUALLY HELPS YOU ACHIEVE FINANCIAL FREEDOM:
Having a rainy-day fund can provide peace of mind and financial security, as unexpected expenses can often lead to financial stress and strain. By setting aside a separate pool of money for these expenses, individuals can avoid having to dip into other savings or investments and stay on track with their long-term financial goals.
All the Best for a Wealthy Life
Qualified Personal Finance Professional (QPFP)
AMFI Registered Mutual Fund Distributor
Author of the Amazon Best Seller books
DON'T RETIRE RICH
WEALTH OF WISDOM
All the best,