What is an Emergency Fund? | Why, Where & How much to save?

A financial plan is a road-map to achieve your life’s financial goals. These goals can be your retirement goal,  Kid’s education goal, vacation planning, purchase of house etc., All of us do try to save and invest in one way or the other for these planned goals.

Life is full of If’s and But’s. Not everything always goes the way we planned. There can be some unpleasant surprises. Whether we like it or not, uncertain moments/events always come announced in our lives.

“Life is not a straight line leading from one blessing to the next and then finally to heaven” – John Piper.

Emergencies can be ; you may require funds to get your car repaired, a medical emergency, house repair, loss of job etc.,

Are you prepared to face these kind of unforeseen contingencies? Do you have an emergency fund? Do you have a contingency plan?

Having a plan for unplanned things is also a very important part of your financial planning. Infact, it forms part of the most important block of your Financial Planning Pyramid!

Investing for your financial life goals may make you/your family wealthy, but saving for an emergency fund may ensure you that you do not become poor. It may ensure you that you do not pull out money which has been accumulated for your other financial goals.

How much Emergency Fund (EF) should you accumulate?

This is a very tough question to answer.

To put it in a simple way, I believe that maintaining a small Emergency Fund is better than having ‘NO FUND’ at all.

The quantum of your contingency fund can be dependent on many factors like ; how stable is your income, type of occupation, your (family) life style, Medical history of self/family, number of dependents on you etc.,

Your EF kitty should be big if you are self-employed or if you have a very irregular flow of income. Also, if you are planning to become an entrepreneur, then you should have sufficient EF.

As a rule of thumb, you may maintain EF in the range of 3 to 12 times of your monthly living expenses. You may even include annual recurring expenses like Kid’s education expenses (annual), EMIs, insurance premium amounts, medical expenses etc., while arriving at your monthly expenses figure.

So,  Emergency Fund = Save for unplanned events + Save for some recurring (short-term, planned/unplanned) events in life.

Where should you save your Emergency Fund?

Your choice of saving avenues for EF should be based on two factors ;

• How liquid are these options? &
• Whether they are associated with any risks?

Saving for unplanned events : Highly advisable not to take any risk and save in those options where you can withdraw the fund instantly or within 1-2 days. You may consider building an emergency fund of at least 3 to 6 months of your monthly expenses (basic needs).

Examples : Cash in Bank, Bank FDs, Bank RDs, Sweep-in accounts (Do not chase for returns, it is not your priority).

Saving for certain Planned / Unplanned and/or Recurring or Non-recurring events as part of EF : Besides above options, you may also consider some options like Liquid Debt funds, Arbitrage Funds, Ultra Short term debt funds etc., (You may look out for these options which are liquid, tax efficient and can give you slightly better returns by taking a bit of risk.)

What is my Family’s saving plan for EF?

We maintain two Emergency Funds. We do not take any risk with one kitty (we call it as ‘rainy day fund’) and maintain around 6 months of our living expenses in Savings account and FDs. We also maintain a second fund, where we save around 6 – 9 months of our living expenses in FDs, Liquid fund & in one Arbitrage Fund (these are in my spouse’s name).

When we believe that the second fund is growing bigger than we intended, we move this money to other medium or long term goals. Also, in the past, it so happened that we withdrew money from second EF kitty and invested in equity mutual funds (when markets have fallen and had to pump in more money into equity funds). However, we have replenished it again. We make sure that we do not touch the first EF kitty for recurring or planned events.

Below is one of the blog reader’s saving plan for his Emergency Fund (mine is very similar to his plan).

Emergency Fund & Important Points 

• Review : Emergency Fund planning is not a one-time activity. You may have to review your saving plan periodically. Also, you need to have a re-look at your contingency fund based on certain events that happen in your life. Your requirements may change over a period of time, but having a certain amount as an Emergency fund is a must, regardless of what stage you are at in your life.
• Emergency Fund for Health expenses : We are all aware of the fact that medical expenses have been growing rapidly. It may be a prudent thing to have a separate Fund for meeting any unforeseen health emergencies. In case, any of your family member / dependent has a medical history of any critical illness, it is highly advisable to have a stand-alone emergency fund (besides having a health insurance cover).
• Credit Card : This is the era of Plastic money! I believe that it is better if you hold at least one Credit card. You may treat your credit card as a part of your Emergency Fund. (A word of caution : Kindly use your credit card judiciously and pay total outstanding bills before the due date. Also, try not to take Personal Loans.)
• Replenish your Emergency Fund : In case, you had to use your Emergency fund to meet any unforeseen contingencies, you have to start re-building it immediately. Live within your means and try to save more to replenish your contingency fund.

Never put your emergency money in a life insurance plan, a corporate fixed deposit, or in any equity mutual fund. Choose products that are highly liquid, safe / less risky and have low premature withdrawal penalties.

In case, you do not have any Emergency fund, it ‘s high time you have one. You may postpone your investments but do not postpone saving for your Emergency fund.

Income – Savings for Emergency fund = Disposable Income – Investments – Expenses = Surplus Income (if any)

“If It Is Important To You, You Will Find A Way. If Not, Will Find An Excuse.” –  Ryan Blair

(Image courtesy of Stuart Miles at FreeDigitalPhotos.net) (Post published on : 18-July-2017)