We are by design very optimistic about everything in our life. Not many of us understand the importance of preparing for an exigency. Talk to someone you know who had an unforeseen incident. They’ll tell you how everything was so smooth and how happy they were before the incident and how it is now. It is at these situations you find yourselves alone and not many helping hands to pull you out of the mess. We all know it wont be easy to borrow money from anyone especially when they know that we would not be in a position to repay them quickly.
Think of this as a personal insurance. An insurance which comes with no conditions. It doesn’t matter if an old man bumps into your car, or you suddenly fall from the stairs. It doesn’t matter if you happen to lose your job because of the economic crisis or if the pandemic hits you. This is the money that will help you tide over the crisis. One thing you wouldn’t want to worry about during a crisis is to worry about your finances. Your mind space would be critical at the time of distress, and you would want to concentrate on coming out of the situation be it finding a new job or fixing your car rather than worrying about finding a source for money.
Have you ever stopped yourselves from making a big investment thinking about an emergency? We miss out on good long term investment opportunities thinking about these emergencies. We do not like our money tied up in a product which does not come good during an exigency. This fear is valid and happens to everyone. This fear can only be tackled by having a decent cushion to safeguard ourselves from those unforeseen situations without taping into our investments or taking the debt route.
How much should I Save for Emergency?
The best way to calculate it is by calculating your monthly expenses. Your expenses should include all your EMIs, medical expenses if any, fuel costs, grocery expenses, bills etc. (An example is provided in previous chapter). Once you calculate your monthly expense, multiply all the unavoidable expense by 3 months. Your first target would be to save this amount. Your second target would be to have a 6-month buffer and then a 12-month buffer.
I understand the size of the amount you would need could be overwhelming. The best way to get there would be to set aside any large fund you already have or to use your bonus ☹ or to move tax refund to emergency fund. If you have access to any large sum in coming few days, it could act as your starter. If not, just like what I had to do, we start saving little month after month. Once we reach the 3 months target, we can afford to move slowly towards the 6 months target.
The idea here is to have enough buffer amount saved so that at the times of difficulties, you can focus on what you must and not depend on external means for funds. The size of the fund should be comfortable enough for you to be able to pay all your bills, medical expenses and rent or EMIs for the time you would need to come out of the distress.
Where do you park your emergency fund?
With emergency fund, you need two things – No loss in value and quick access (also called as liquid). You have to ensure that the value of the amount never depletes and at the same time you should be able to access enough funds at any given point in time. This does not mean it should be lying around in savings account. Savings account gives the lowest rate of interest among all the possibilities you would have though they are most accessible. Another option would be to keep them in Fixed Deposit (FD). They do give better returns compared to savings account, but you are tied up for a certain time period. Though you can break FDs, it wouldn’t be advisable to do so.
Now, there are two types of mutual funds that we can start looking at – Liquid funds or Short term debt funds.
We will discuss these funds in detail in further chapters. These funds in short, are debt mutual funds which gives returns close to (or more than) savings interest rates/ FD interest rates while you can have the funds within 24 hours with out any exit penalty.
So as a thumb rule, you can keep 25% of your total emergency fund in a savings account (the separate account for emergency we talked about in banks chapter). If you think that it would be difficult to use the debit card for this account, you can consider keeping small percentage (say 10%) in cash. This 25% of the amount is for you to tide over until you can have access to your funds in liquid/ short term fund. Once you have 25% in savings account, the remaining 75% of the total emergency fund can be moved to a liquid/ short term funds.
God forbid, we never get to use this fund :)
Comments