Personal Finance: How to save and where to invest to create an emergency fund

An emergency fund plays a crucial role in fulfilling your dreams. Hence, building or rebuilding it is as important as making investments

Viral BhattUpdated: Saturday, January 29, 2022, 01:39 PM IST
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An emergency fund is not important from the perspective of many. However, its importance cannot be ignored at all. Emergency — be it medical, financial or even social — may lead to unnecessary stress expensive borrowings or unplanned liquidation of savings. Many of us get to know its importance by experiencing it off guard, and by that time it becomes too late to tackle the issue. Therefore, it is necessary to set aside a small but considerable amount of chunk for contingencies. There is no vaccination for a crisis, but to lock its impact on your finances, you can plan the emergency fund in advance. An emergency fund is important but how to plan it? How much amount is sufficient for an emergency? Let us check that out.

To understand how to plan an emergency fund, one needs to know how much money can be sufficient. To simplify, let us take an example of a financial emergency, wherein if you are a salaried person with a monthly remuneration of Rs 25,000, then in case of sudden job loss, your emergency fund should be Rs 1,00,000 to Rs 1,50,000, that is, minimum of four months to six months' salary. Thus, it gives you enough time to take a break and get back into employment without any additional stress. In case of medical, it is always advisable to have medical insurance inclusive of your parents or in-laws, however, Plan B must be kept ready.

Now since we know how much fund can be sufficient, how can one create such a fund? An emergency fund is the most difficult part to save. Prudent financial planning cannot be completed without the creation of an emergency fund — imagine spending the down payment of your car for your rent in case of sudden job loss! A 5-10% of your monthly income should help you build your emergency fund steadily without disturbing your other savings. Although, for beginners, the safest option is to create an emergency fund first and then start with your other savings.

Emergency fund calls for money at shorter notice and should be in highly liquid form or else the very objective of the fund gets defeated. Now, liquid form in simple terms means cash, but keeping large cash at home can be an invitation to thieves. Thus, investing the same in such options which can render you the money immediately makes more sense in addition to the returns attached to such investments. So, what are these investment avenues?

  1. Liquid Mutual fund — Returns: 3-4%;

  2. Short term debt funds — Returns: 5-6%;

  3. Fixed and Recurring Deposit — Returns: 4-5%

  4. Savings Account: 3-4%

The above four are highly liquid yet 'making your money work' kind of investment avenues, which are highly recommended for building your emergency fund. However, it is important to note that over-concentration on anyone cannot be helpful, hence scattering the investment across the spectrum is also noteworthy. Depending upon the health of dependents employment environment or general recessionary trend, one can decide how to allocate the funds. For example, if parents are above 75 years of age, keeping 40% of the investment in savings is recommended.

An emergency fund plays a crucial role in fulfilling your dreams. Hence, building or rebuilding it is as important as making investments. But mere building the fund does not end the process. It is also important to review the same based on inflation or dependent’s age, increase in the number of dependents, debt incurred, lifestyle, etc.

(The writer is the Founder of Money Mantra, a personal finance solutions firm)

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