Importance & need of emergency funds
Emergency fund is money which comes to your rescue when something unexpected pops up in our daily routine. One needs an emergency fund as life is very unpredictable. Something that can go wrong will eventually go wrong at wrong time.
Just think of emergency fund as a lifeline thrown at you when you are drowning and this article is about creating that lifeline yourself
One may need to travel unexpectedly (we all know how much bomb a ticket costs at last minute) or there could be medical emergency (Generally Life insurance or medical insurance will work for this but by the time insurance claim comes to you, you need to survive yourself and family and pay hospital bills) You need funds for that.
Or worse if you are working in an industry where jobs are not secure and layoffs are frequent, such a fund becomes mandatory.
You wouldn’t be forced to reach out to family or your so called friends for help and further You also wouldn’t have to accept the first job offer that lands on your plate in such a scenario
How much to keep aside for emergency funds
Basic Thumb rule is to have minimum of 3 months and maximum of 12 months of expenses as your emergency funds. e.g, if your monthly income is Rs. 50000 and you spend Rs 45000 month on an average and save 5000 Rs per month then you should have minimum 45000*3 =135000 as your emergency fund.
- Minimum of 3 month expenses in highly liquid form (365*24*7)
- Minimum of 3 month expenses in fast-accessible liquid form (T+1 days)
- Approximate 3 month expenses in easily accessible liquid form (T+3 days)
- Approximate 3 month expenses to be put aside in somewhat inaccessible liquid form e.g. 9 month fixed deposit or 1 year fixed deposit
Best way to calculate emergency fund
- Monthly Expenses should cover Home EMI, personal loans, car loan installments, household expenses, school fees, grocery bills, phone bills, personal grooming expenses etc.
- Best way to arrive at monthly expenditure is to divide yearly expenditure by 12. This is only possible if you know your yearly expenditure by having household budget and maintain every single expense in that.
- Second best way is to add all major expenses in a year and divide by 10 (instead of 12) to arrive at approximate monthly expense.
- To hedge against inflation, multiply this emergency fund by 1.1 to arrive at real number assuming a 10% inflation in education, travel & medical fields
Review of emergency funds
- Review it on yearly basis
- Keep adding some money to emergency fund based on increased expenses
- Adjust for inflation and add funds accordingly
- Foresee any emergency in next few months and add funds
Where to keep emergency funds and accessibility time
|Asset||%age of emergency fund||Storage mode||How to |
|Cash||15 %||Safe vault at home||Direct||365*24*7|
|Liquid Bank Balance||50%||FD/RD/Saving account||Cheque/NEFT/|
|365*24*7 to T+(1 to 2) working days|
|Debt Mutual Funds||30%||Ultra short duration funds, liquid funds||Demat account/|
|T+(1 to 2) working days|
|Gold||not more than 5-10%||Safe vault at home||Sell to Jeweler||Jeweler working hours|
|Other avenues which can be used||How much % to use in case of emergency||How to use||Advantage||Disadvantage|
|Credit card||25%||Make a habit to not cross 75% of allocated limit. Reserve 25% of credit card limit as emergency fund usage||It will give you 20-40 days to arrange funds from other resources.||Debt trap|
|Real estate||Neither recommended nor preferred||Additional plot/flat can be used to serve this purpose||Huge amount will be available||Highly illiquid. May be sold at high discount to market in emergency and may take months|
equity Mutual funds
|Neither recommended nor preferred||Sell in market||Emergency funds may grow faster||May be sold at high discount to market in emergency. T+3 working days to access funds|
Also Read :
Gateway to Wealth creation
You can safely assume the emergency fund as gateway to wealth creation. Until you pass this gateway, dont dare to think of entering stock market.
The point i want to bring to your attention is — if you have build up emergency fund and saved enough money further (approximate 2 year expenses) in bank account then such a huge money can give you access to new opportunities in stock market.
Let’s say the economy crashes and potential layoff’s are round the corner and eventually stock market crashes and asset prices are below their intrinsic values. In such a scenario, instead of selling your stocks at penny prices, you would have enough disposable money to take advantage of stock market and build up new positions without fear.
Do keep in mind that Stock market is a risky place and there could be times where the market is down for quite a long time and you do not want to sell your securities at highly discounted rate, this kind of emergency fund may help you to pass through such bad times without worrying about any unforeseen risks in your daily life.
Last but not the least You need to have more than few of the personal qualities to succeed e.g.
- Always maintain the emergency fund and review it on yearly basis.
- Increase the emergency fund every year
- You have willingness to admit to mistakes and flexible to change your views.
- You do not panic frequently at home/office
- You can deal with uncertainty with ease
- You have disciplined approach and follow process instead of gut feelings in decision making
- You are self reliant and willing to do an independent research
In case you have any questions/ queries, please feel free to reach me through Contact Form
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Enjoy the day and your life. Don’t forget, we are alone in this grand universe and may not get a chance to live again.