Emergency Fund: Saviour for rainy days

“We naturally fear the unknown, and the future is always unknown” – Peter Bernstein

The financial crisis, job losses, war, prolonged recession, natural disaster, global pandemic are a few of such excruciating situations where one is stuck in dire need of money. Ensuring the sufficient and swift accessible fund is enabling comfortable sailing rides without additional financial burden. The ultimate purpose of an emergency fund is not to get a higher return but to safeguard the long-term investment and financial miseries. It is important aspects of personal financial planning but dejectedly underrated. An emergency fund ensures the entire obligatory requirement for monthly expenditure and unplanned expenses
without which, it caused financial distress, anxiety, and a huge debt trap to personal loans/credit or debit cards. Although, there is no standard list of the items one can customize based on personal lifestyle and routine expenditure. Some of the items considered for essential expenditure includes are,

·         Food expense and groceries

·         Monthly rent

·         Schools fees

·         EMI of loans

·         Medical expenditure and insurance premium

·         Monthly bills include mobile recharge, electricity, gas, etc

Systematically guide to build and invest emergency reserve

There is no concrete rule of thumb to follow on how much amount one should have as emergency corpus ideally, one must have at least six months to cover monthly expenditures. The amount could be covering a one-year monthly expenditure if the person is working in an uncertain environment and job loss fear. Here are the steps by step guide to follow;

1.      Decide the amount based on monthly expenditure: Calculate the monthly expenses of the above listed and add more items as per your needs. This gives a clear idea of monthly expenditure. Multiply with the number of months (6 months or 12 months) to calculate the total emergency amount. For instance, monthly expenditure including the above item is suppose Rs. 20000 than emergency corpus for 6 months should be Rs. 120000 and 240000 for 1 year. The amount solely depends on family situation and lifestyle. It is imperative to recognize that financial need varies to every person. Therefore, a periodical review is crucial to prevent unforeseen events. Always be better to have a large corpus.

2.      Set the target and begin with the fixed portion of monthly salary in a separate account: People usually do not have a lump sum amount available. It would be prudent to put a certain amount of monthly salary say 5 to 8 % in a separate account until your total amount is built. In between this period, if the need arises one can access the emergency corpus and replenish it periodically. Suppose a person has a monthly salary of Rs. 30000 then Rs. 1500 to 2400 must be set aside in separate accounts regularly. Discipline is the key to investment.

3.      Invest in liquid assets: Accessibility and quicker redemption is a paramount objective before building the emergency fund. At a time of sudden need, one can easily withdraw and mobilized funds swiftly. Avoid illiquid assets such as PPF, ELSS fund, RD, National Saving Certificate (NSS), Long term FD, Sovereign Gold Bond (SGB), etc. It is, therefore, indispensable to invest in liquid assets. One can be considered the flowing investment option:

A.    Cash

B.     Saving account

C.     Liquid / Overnight mutual fund

D.    Short term FD

Thumb rule to save: Let us assume that the total emergency reserve that needs to be built is Rs. 120000. It is better to split the whole corpus and allocate it to different investment instruments. The general rule of thumb is the 20:30:50 ratio for the deployment of an emergency fund. It may be varied depending upon how often the fund is required in the given period. Keep 20% of the fund (Rs. 24000) as cash, another 30% of the fund (Rs. 36000) in bank savings bank account, and the rest 50% of the fund (Rs. 60000) should be parked in a liquid fund.