‘Emergency fund or contingency fund’ is crucial part of personal finance. You must be coming across various articles, videos, blogs talking about it & emphasizing its importance.
Its true that you should have one for you.
We live in a world which is affected by micro & macro-economic situations. Such changes affect our job, business or profession we belong to.
Many people always face the risk of job loss or pay cut, loss of profit despite working hard in their respective job, business or profession.
On the other hand, natural calamities, threats like Pandemic are there to add the fear.
When faced with such unforeseen situation, a person should focus on ‘finding the solution, get out of the situation quick as possible’. He/she should not worry about paying off the bills & run a household.
So, to keep ‘financial independence intact in any unforeseen situations in life, you must have your own ‘emergency fund’ ready with you!’
However, many such literature talk about thumb rule quoting the required amount of contingency fund one should have. It is right but in ‘general sense’.
When it comes to your personal finance, you should acknowledge, check & verify some facts which are related to you exclusively. This will guide you about the ‘right & suitable amount of emergency fund’ for you!
I am hereby explaining some simple things which you should check for you to-
- Decide on the required emergency fund
- Way to create the same
- Investment options to consider for the same
So, here is a simple checklist:
- Check about your ‘financial stability’!
Today, workforce has major three parts where one is in private sector, we have other part of the workforce who is employed in government or semi government organizations & other part is from businesses, start-ups, agriculture, service sector, etc.
Salaried class, whether in private, government or semi government sector, get ‘fixed income’ per month based on work cadre & agreed terms of employment.
People who are self employed or get business income have ‘flexible income’.
Again, ‘financial strength’ of the organization matters a lot for salaried class to ‘define & assure about their financial stability’ even though they ‘get fixed pay’.
Self-employed, professionals & business people draw flexible income, but competitive ability of their business or service, scope for innovation matters the most.
Above factors help to ‘decide financial stability’.
So, if you are a ‘salaried person’ then don’t be ‘care-free’ & if you are self employed or professional or businessman, then don’t be in ‘worry’ always about your finances.
Take a stock of the situation from time to time because today we live in a dynamic world.
- Count on your ‘real monthly expenses’:
We send money on many things. Some are repetitive expenses like paying off utility bills, education fees etc.
Some are voluntary expenses like shopping, giving gifts etc.
Every person & family spends differently.
Our nature, thoughts & wants define our ‘spending habits’. You must acknowledge them.
I ask you to start noting down your monthly expenses. Count on those which you really need to spend on like fees, medical bills, utility bills, travel, grocery, loan EMIs etc.
Calculate & decide that amount.
- Check your ‘financial dependency’:
Every person comes with some or the other dependency on him /her. When it comes to ‘financial dependency’, you have other people depending upon you ‘for their expenses & wellbeing’.
A person, who has such financial dependency, need to be careful & responsible enough while spending, earning & investing.
Check for you, how much financial dependency do you have upon you.
- Check for your ‘financial liability’:
Financial liability occurs when you have opted for some loans. Here, you need to pay respective EMI per month for the loan tenure.
This financial liability is common these days due to availability of easy loans via credit cards, personal loans etc.
Check how much are you ‘liable to pay’ & ‘for how long’.
When you have this check list ready, what’s next?
Next is ‘deciding the amount of emergency fund’:
For this, please check & acknowledge the following.
If you are salaried or self-employed with organization who has bright growth ahead, if you do not have any ‘financial liability or dependency’, then you can opt for a ‘emergency fund’ equivalent to 6-8 months of your ‘monthly expenses’.
If the situation is opposite, then you must have ‘emergency fund equivalent to minimum 1.5- 2 years of monthly expenses.
The amount of ‘emergency corpus’ when created as per your ‘financial position’ will be justified & give you confidence to stand well in difficult situations.
Its not justified to create ‘emergency fund’ equivalent to 1.5 -2 years of monthly expenses when you have ‘no financial dependency or liability’. That money you can invest for some other future goal.
How to create it?
‘Emergency fund’ is the ‘base of any financial plan’! When you think of starting your financial planning, emergency fund must be the first to look after.
To accumulate the required amount of ‘emergency fund’, You have two options!
Follow 4 easy steps:
- You need to first screen & view your ‘existing investments in short term investment options’. E.g. short term bank FDs, money kept in savings a/c, cash holdings with you if any, investments in short term debt funds like liquid funds etc.
- Here, you need to make a list of all of them & calculate the amount put together.
- If the amount is sufficient for your ‘emergency fund’ then its good. Mark them as your ‘emergency fund’. If not, then mark them as ‘a part of your emergency fund’. Accumulate the remaining amount by investing on a monthly basis in suitable instrument.
Calculate the amount required for your ‘emergency fund’. If you do not have any short-term investment made so far, then start accumulating the required corpus.
Start investing on a monthly basis, in disciplined way, in suitable debt instrument.
Prioritize this investment, accumulate it first in the span of 1 / 2 years.
Where to invest your ‘emergency fund’?
‘Emergency fund’ need to be invested in investment option which has 3 features-
- Investment option which you understand in detail
- Where You can transact in them easily
- Where you can withdraw the money, you need easily & also you can receive your money in ‘shortest span of time’.
With this, I am giving you following options for investing-
- Cash holdings:
You can keep cash balance with you which is equivalent to 1 month of your ‘monthly household expenses’. This will give you confidence to spend freely in case of any emergency situation like natural calamity, situation like pandemic etc.
- Savings a/c:
Savings a/c is your go- to place to transact & withdraw money from easily. You can keep a balance in your savings a/c which is equivalent to 3 / 4 months of your monthly household expenses.
In case of emergency, you can spend from this balance for the period. If your get solution to your problem within this period, then you don’t need to touch your investments in other options.
- Short term Bank FD:
Bank FDs are simple & popular investment instrument where you can invest easily. Bank FDs give pre-defined taxable rate of interest for the tenure of investment you choose.
You can withdraw it pre-maturely with some % of penalty that respective bank charges.
It can make your money available to you in short period of time.
- Sweep-in FDs:
Today, majority of all banks offer savings a/c with ‘sweep-in bank FD facility.
Here, if you get some windfall gains or profit or a bonus amount in your savings a/c, then you can ‘transfer it to Fixed deposits’ via ‘sweep-in facility’.
When you need the money, you can easily break the FD prematurely & then can utilize the same.
- Short term debt funds:
Short term debt funds are important investment options. They are market linked & invest in debt papers of various maturity & credit ratings based on their respective scheme objective.
Ideally, you can choose debt funds from very short-term category like liquid funds to invest your emergency fund money.
Liquid funds, as the name goes, have high liquidity where you can withdraw funds you need & receive it in your linked bank a/c in T+1 day.
It gives diversification to your portfolio for emergency fund.
Liquid funds invest in very short-term maturity papers like 7 days, 30 days, 90 days etc.
Here, you get ‘flexibility to redeem money which you need exactly. Remaining amount can remain invested to give you potential best returns.
So, divide the amount of your emergency fund in any of the above instrument where you find it easy to understand, transact & withdraw the money from.
Things to keep in mind wrt Emergency fund:
When you accumulate your ‘Emergency fund’, please keep the following in mind to follow-
- Emergency fund is meant to be used for ‘emergency situations’ where you need the money to run your household. Please use it in such situations only.
- Emergency fund should always be reviewed & upgraded. Amount of your monthly expenses change due to inflation, increasing responsibilities, increased standard of living. Your emergency fund should ensure that, you will never fall short of money when you need it the most.
- You should not expect ‘high returns’ from ‘emergency fund’ corpus invested. The purpose of this fund & corpus is altogether different. To generate high returns, you can invest in direct equity, equity mutual funds suitable to you.
Start building up one for you NOW!