The Covid-19 pandemic has been an eye-opener. Life hates being in a straight line. There are multiple situations, which may pop up without a disclaimer and you will be left without a choice. There may be a sudden layoff at work, a medical emergency in your family, some loss in business, a tax liability you never heard of or the worst — an economic meltdown impacting your savings. However, if you are wise enough with your money, then you know such an unexpected and unplanned situation calls for an emergency fund. And this fund is vital for all age groups. You need an emergency fund right from the day you join a workplace and officially start living without your dad’s money or bank loans.
Do remember that this particular emergency fund isn’t meant for planned purchases such as a house, a new car or a professional course. Neither is this fund a set amount for all age and lifestyle needs. It doesn’t have to be a large, unattainable amount, rather one should start with something small.
How much should one save for emergency?
The thumb rule says an individual must save an amount that will tide him or her over three to six months of unavoidable household expenses. The amount, of course, will vary for each individual, based on a number of factors. These will include number of earning members in a family, number of dependents, nature of employment, nature of fixed expenses, EMIs, insurance premiums, rent, maintenance and other daily expenses.
Now, do you have a well-planned health insurance? If you have a corporate one provided by your employers or a cashless one of your own, you can heave a sigh of relief as you are equipped for a medical emergency. Do remember that the quantum of emergency fund amount varies on a case-to-case basis. But when you start your professional life early, the needs in life are smaller and so it’s easy to create an emergency fund.
Where exactly should you park your emergency fund?
Emergency funds, by definition, should be easily accessible at all times. It’s hard to predict the scale of emergency but it can be co-related to one’s situation. For instance, whether you are single, or living with older parents or have kids or if you are self-employed. No matter how easily accessible an emergency fund is, nothing beats the comfort of having some cash at hand. So at least 10-15 per cent of one’s emergency fund should be in cash.
The next allocation of the emergency fund should be in a savings account with auto sweep facility wherein, when your savings account balance exceeds a certain limit, the excess money is put into an FD. The threshold can be anywhere between Rs 25, 000 and Rs 1 lakh. The FD would have a minimum maturity period as decided by the bank and there can be penalties for early withdrawal. However, keep in mind that that should not be a consideration for emergency funds.
A certain portion of the emergency fund can also be deployed in liquid funds. Liquid fund is a category of mutual funds, which invest primarily in market instruments including certificate of deposits, treasury bills, commercial papers and term deposits. These funds have varying levels of returns. For instance, the range of returns for liquid funds with a duration of one to six months is 0.9% to 4.5%.
Withdrawals from liquid funds are processed within 24 hours on business days. The cut-off time on withdrawal is generally 2 pm on business days. So if you place a redemption request by 2 pm on a business day, then the funds will be credited to your bank account on the next business day by 10 am.
A portion of the emergency fund can also be kept in highly liquid debt mutual funds, the returns on which are secure and at currently in the range of 7.5 % to 10%, depending on the type of fund. The idea behind this allocation is to have a safe and liquid investment that gives higher returns than a typical bank fixed deposit with a similar time horizon.
Company medical insurance may not be sufficient
Even if your company provides you health insurance, you still need to have an emergency fund as you need sufficient cushion for untoward, unplanned situations which are not just limited to medical exigencies.
Additionally, an employer-provided medical insurance cover might not be enough at the moment. Health insurance does come with reasonable restrictions and caps and even with cashless insurance, sometimes you have to deposit some cash upfront at the hospital. So it is always good to have an emergency fund for situations like those.
Is it advisable to take a loan to build an emergency fund?
No, you shouldn’t hurry that much. The whole idea to have an emergency fund is that one should not have to take a loan in cases of emergencies! If you think you cannot save enough or do not have enough in the emergency fund, don’t panic. Just keep saving every extra bit you have and over time you will have a sufficient kitty. It is, however, important to have access to emergency funds, for instance, soft loans from friends and family on easier payment terms as well as a credit card with some spending limit that can serve as a last resort in case of an emergency.