The importance of an emergency fund has never been this apparent.
To be fair, even I never did give it much thought till last year. When Jet Airways collapsed, three pilots I personally knew had the carpet pulled from right under their feet. They had to worry about providing for their families and paying their equated monthly instalments (EMIs) on their home loans. Now, I am convinced on the need for an emergency fund.
Where must you keep this money? –
Most people keep a bank fixed deposit as an emergency fund. But emergencies, by nature, do not occur frequently. One may not have to dip into this kitty for years on end. So, if you are looking at a vehicle that generates a better post-tax return, you could also consider a Liquid/Ultra Short-Term Bond Fund. Investing in very short duration mutual fund scheme can give the benefit of indexation as well.
Or, it need not be either. It could be a combination of both.
Please do not rely on:
- Your credit card. You will be straddled with a very high interest rate and eventually land up in debt.
- Your existing investments. If you use your existing investments to help you out in an emergency, you are doing yourself a big disservice. Don’t touch your retirement kitty or child’s education fund as far as possible. To stop contributing to this goal and pull money out from there, will backfire in the long run.
- Borrowing from family or friends.
What to keep in mind?
- Have a concrete number in mind. And put in effort to ensure that it is as accurate as possible. Do not be vague.
- Never put returns as the prime factor of your emergency fund. Returns should be the least of your concerns.
- Ensure that others can tap into this fund. If you meet with an accident and cannot withdraw the money, the purpose is defeated. Make sure it is a joint holding.
- You can build it gradually. If you decide that Rs 10 lakh needs to be your emergency fund, don’t panic if you do not have the money right away. Build it over time.
- Don’t stick to the same amount you conceptualised years ago. The number of your dependents may increase; you may have another child or a parent may move in. Your spouse may have given up her job to be a home maker or start a new business. You may have taken on some debt.
Don’t go by what others suggest. Put in the hard work to come up with a number customized to your life. Depending on whether other family members are employed, you can look at 6 to 12 months of living expenses. Do note, these are mostly basic expenses, not lifestyle costs. Look at all these issues.
- House: EMIs on your home loan, rent, monthly society outgoings
- Basic expenses: Groceries, electricity bill, water bill, medication, necessities
- Salaries: Driver, house help
- Fees of children: School, tuition, other activities like music or dance classes
- Sporadic Payments: Premiums towards health and life insurance, payments for Netflix and cable, gym membership
- Investments: If you can truly afford it, it would be good if you even budget for your systematic investments in funds, though you can be flexible on this.
An emergency can be emotionally very stressful. Don’t add financial stress to it. Be prepared, as far as possible.