Most people think they have nothing to worry about until something unexpected happens. This suddenness can catch you off-guard without any financial preparation. Something as simple as being late on a bill or as extreme as being robbed and watching something they’ve worked hard for disappear in minutes.
The recent experience with Covid-19, made everyone realise the emotional and even financial preparation they had, or the lack of it. The last two years saw job loss, salary cuts, deaths, and many unimaginable emergencies.
During the second wave of Covid infections in India, around 20-23% of affected people had to visit the hospital for treatment. During the third wave, however, only 5-10% of people so far have needed hospital care. But as we have experienced, situations can turn any moment.
The hospitalisation costs have been high during the second wave, and shortage even led to black marketing of essential medicines. If we are not financially prepared for times like these, we could be losing all our savings in one go.
Whether its Covid-19 or any other unforeseen circumstances, the need for adequate emergency funds has never been more apparent.
What is an Emergency Fund?
An emergency fund is a fund where you save money regularly, to help you meet obligatory expenses without taking a last-minute loan or selling your assets. Obligatory expenses are those which are essential for your day-to-day life and cannot be avoided, such as food, rent, EMI, basic repairs and maintenance, insurance premiums, etc.
However, obligatory expenses could mean keeping a domestic staff, chauffeurs, or going to a gym for some individuals. It will vary depending on income and lifestyle.
An emergency fund will help you carry on your life, as usual, become financially secure, and it will also provide a safety net in case of an emergency.
How to Save for an Emergency Fund?
Start with a beautiful quote on savings by Warren Buffett.
“Do not save what is left after spending, but spend what is left after saving.”
For saving, the most important thing to do is budgeting.
- As a first step, figure out what your spending is. This involves keeping track of all your obligatory and discretionary expenses.
- Post this, make a budget that will show how your expenses measure up to your income. Now, plan your spending, try to cut unnecessary and impulse expenditures and set up short-term and long-term goals.
- Next, estimate the money required in your emergency fund. The amount could differ for every individual.
- Once you know your requirement, start saving each month to build a corpus.
How much should be your Emergency Fund?
Each individual can have different amounts in the emergency fund depending on factors such as age, the number of dependents, income, health, lifestyle, etc.
If you are the only earning member with dependents and kids, you might want to save more to cover expenses for all, and if you are single and have no dependents, you could save less counting only your expenses.
However, it is believed that to be financially secure, an individual should have three to six months of living expenses saved.
For example, if your monthly expenses are Rs. 40,000, then you should have anywhere between Rs. 1, 20,000 to Rs. 2, 40,000 at any time.
Investment Avenues for Emergency Fund
Find a lucrative and safe instrument to invest the money once you know how much to keep in an emergency fund.
An emergency fund has only one objective, to provide you funds when you need them, without any delay.
Ideally you can invest your money in a liquid instrument that has no lock-in period.
Individuals should avoid having an inadequate emergency fund that will be unable to meet their expenses.
The options available to an investor are:
- Cash
Cash is the most liquid instrument in case of emergencies. There might be times when you are unable to visit a bank to withdraw money or when online payment is not accepted. However, cash should be kept only minimal.
- Savings account
Keeping money in a savings account is just like maintaining cash, but with some interest component. A savings account is a very safe instrument and will also provide you with some returns. In a savings account, you can also withdraw money at any time without any withdrawal fees.
- Short-term fixed deposits
You could also think of investing in a short-term fixed deposit. It is also a very safe instrument that will provide you with better returns as compared to a savings account. However, check the terms and conditions withdrawal fee before opening a deposit account. You can take out an emergency loan against your fixed deposits.
- Overnight funds
Debt funds that invest in overnight securities are known as overnight funds.
Overnight funds have zero interest rate risk and minimum credit risk, thus they are among the safest debt funds. They also provide better returns than fixed deposits and are more liquid.
- Liquid mutual funds
Liquid mutual funds are also an excellent investment option to park your emergency funds, and they invest in short-term money market instruments having a maturity of up to 90 days. The short-term money market instruments include Certificates of Deposits, Term Bills, etc. They offer a higher return than fixed deposits and are more liquid.
However, they carry an exit load if redeemed before seven days. If liquid mutual funds are redeemed before three years, then they are also subject to capital gains tax.
Avoid investing in just one instrument but split up your emergency funds among the above instruments based on your risk level.
You should also avoid investing your emergency funds in highly volatile assets, such as equities, equity mutual funds, corporate bonds, etc., or instruments with more extended lock-in periods, such as Public Provident Fund (PPF) and National Savings Certificate (NSC), etc.
Conclusion
“Someone’s sitting in the shade today because someone planted a tree a long time ago.” — Warren Buffett.
If you want to have funds during an emergency, start saving money for your emergency fund today.
It is critical for investors to have an emergency fund to meet the unexpected liquidity needs that may arise in their life’s journey and cannot be postponed.
For many of us, Covid-19 has been a warning.
As per a recent survey, 51% of people have started to save more than before, and 36% of people are investing more in wealth creation.
You can think of an emergency fund as your parachute that will save you from falling.
Building an emergency fund is not enough. You need to review it at least once a year, as there could be changes in your financial goals and needs.
Reach out to at:contact@sbsfin.com for more investment avenues for liquidity.