If life is a cricket match, not every ball is going to be easy. There will be yorkers, bouncers and googlies. The question is how prepared are you to handle these yorkers and bouncers? Take, for example, the story of Allie and Steve who worked in the same company. In 2022 when the couple had just had a baby, the company fired them. Imagine the kind of distress they would have been in if they had not saved for an emergency. Emergencies don’t knock at the door, they barge in. And the only weapon to fight these emergencies is liquid money kept aside to handle such situations. Lack of emergency funds push people to poverty. Investing comes at a later stage. First, you need to make sure that you will still be financially secure for at least 6 months even if you lose your job or need to spend a huge amount of money due to any other emergency.
Before Building an Emergency Fund, Define ‘Emergency’
When we talk about emergency funds, we basically have a theoretical concept in mind. However, for an emergency fund to be truly helpful in times of crisis, you need to define what an ‘emergency’ is.
Emergency in an individual’s life can be many things. But, as a rule of thumb, these situations should be prioritized:
- Job loss: You need to have at least 6 months of runway in case of a job loss.
- Medical emergency: Even if you have health insurance, you might incur significant out-of-pocket expenses. These expenses are unexpected.
- Other emergencies that are somewhat expected, for example – house repair, car repair etc.
Among these, the first two are the most crucial as these two scenarios are not only unexpected but expensive as well.
What Happens When You Don’t Have an Emergency Fund?
For a middle class person who has her hard money invested for the medium and long term, the lack of emergency funds will force her to use the money that she shouldn’t be using in the present. In such a case, her financial future is jeopardised.
For people who aren’t even that fortunate to have substantial savings or investments – who live paycheck to paycheck, lack of emergency funds can be disastrous. In the case of such people, unexpected emergencies not only deplete their life savings but also push them to poverty.
Where Do I Keep My Emergency Fund?
Financial goals usually have two aspects:
- Where the money is being invested / saved and how big the corpus should be based on an individual’s needs and plans.
- For how long will it be invested
In the case of building an emergency fund, the second aspect is irrelevant. Because emergencies don’t come knocking at the door. So, one might need the emergency fund today, the next morning or perhaps, the next week. Hence, you can’t lock your emergency fund into any long term investment plan with no option to redeem.
Keeping the above in mind, these are the three primary ‘places’ where you can save your emergency money:
- Cash Within Your Reach
The most basic kind of emergency fund is keeping some cash handy in your house. This keeps you prepared to face any unexpected emergency no matter whether it is a bank holiday, no matter whether your nearest ATM is functional or not and no matter whether it is midnight or early morning. Make sure that you let your family members know where you have kept this emergency cash in the house.
- Savings Bank Account
You can’t keep a huge amount of cash in your home. So the next best liquid option to save your emergency money is a savings bank account. With an ATM card, your emergency fund in the savings bank account remains accessible pretty much 24*7.
- Liquid Investment Options
Can you get some return out of our emergency fund without locking it in? Yes, by investing it in a liquid mutual fund. Liquid mutual funds give better returns than the returns generated by cash kept in a savings bank account. And they offer instant redemption upto Rs.50000. Then comes money market funds and other debt funds. While they are not entirely liquid, they can be redeemed easily without the fear of volatility. However it takes a day for the money to be deposited in your bank account.
How Much Is Enough For an Emergency Fund
The general rule of thumb is, your emergency fund should be at least 6 times the average monthly expenses that you incur presently. This way you can have at least 6 months of runway in case of a job loss and a sizable amount of emergency money in case of other emergencies.
What if you don’t have that much money to keep aside? In that case, first see if you can shift some amount of money from your other investments to your emergency fund. If you don’t have any substantial investments, then start slow. You can invest in a liquid mutual fund SIP and start with as low as Rs.500 per month. Remember, starting is the key here. The sooner you start saving for the rainy days, the better it is.
Conclusion:
Abraham Heschel once said, “No one can write his autobiography in advance.” Yes, life is unpredictable. And the only way to be in control even in this unpredictability is by making sure that you are financially strong enough to look at the unpredictability in the eye. Building an emergency fund gives you confidence to face life and go on with a smiling face.
-Nischay Avichal
