Rainy day cash: How much to save and where to stash

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We are often told by our parents, elders and financial advisors to put aside some amount for the so-called 'rainy day'. However, like many other financial truisms such as to save for the retirement, not to be greedy for super-normal returns, to keep away from credit cards etc., this one too sadly remains just on paper.

 

These are highly uncertain times. Job loss, accident, natural disaster, medical emergency, car/computer breakdown and many such events can happen to anyone, anytime. And such unfortunate incidents, which may require a fairly large amount of money, can upset our financial balance.

 

Having adequate money handy for meeting such unforeseen, irregular and unexpected expenses 

• Spares us the mental agony of arranging money at a very short notice
• Protects our long-term investment corpus from such shocks and
• Gives us time to realign the long-term finances in line with the new financial realities, if need be.

How much is enough?

The emergency corpus that we need to build-up depends a lot on our financial position. Most financial experts recommend anything between three-four months of the monthly expenses to be kept aside for emergencies.

                                                

Assuming average household expenses of Rs 15,000 per month, the emergency corpus that we need to have, may work out to around Rs 40,000-50,000. This amount should usually be sufficient to tide over short-term financial crisis. It offers us all-important breathing space to assess the damage and take right decisions while going forward.

 

Too less an amount will defeat the very purpose of such a fund. And too large a fund would mean loss of opportunity to invest it for higher returns. Therefore, finding the right balance is essential.

 

Ways to accumulate emergency corpus

This is a fairly large amount and may at a first glance appear intimidating. But, remember we don't have to have this corpus from tomorrow itself.

 

We can build it up over say next 6-months to 1-year, depending on our financial capability. But we have to have a definite time frame. Otherwise, things will linger on; we will keep spending on some thing or the other and the emergency corpus will never happen. We must assume it to be like any other monthly bill, which we have to pay-off.

 

Now, if we think of saving say Rs.2000-3000 every month, the target looks less intimidating and reasonable. This can be achieved by cutting down or limiting some of the non-essential expenses like the weekly movie-cum-dinner outing, saving on the cell-phone bills, not overspending on vacation trips, etc; or even keeping aside a part of the annual bonus.

 

Advance planning

Emergency means something unforeseen. But it has been seen that we sometimes create an emergency situation by not planning things properly.

 

Many a times, we forget about large annual payments like say the insurance premium. Or say a marriage that is expected in the family, which will require some spending on clothes, travel and a gift. Or say the birthdays/anniversaries. These are not un-expected expenses. They are irregular expenses. But quite often we fail to plan for them.

 

It is only when the due date is near that we realize we don't have sufficient cash. We then have to break some long-term investment to arrange the cash, which entails a loss. Or we have to use credit card, which works out quite expensive. In fact, quite a few people get into debt as they don't plan there expenses properly.

 

We need not wait till the event happens. It is better to make a provision for such expenses from the regular monthly income.

 

Where to park this money?

This money is essentially short-term money, which should be easily available as it can be required anytime. Therefore, it cannot be invested for long periods and in instruments where it is difficult to withdraw it.

 

For example, in Equity Linked Savings Scheme (ELSS) funds, there is a lock-in of 3 years. So money in ELSS funds is not readily available when we need it. Or say Public Provident Fund (PPF) or National Savings Certificate (NSC) etc. But we also can't leave it idle in a savings account as the returns are very low at 3.5%.

 

Many banks offer a Fixed Deposit (FD) - linked savings account. Herein the money is kept in an FD, but can be withdrawn anytime we want to; even through the ATM card. We can take advantage of this facility by keeping this amount in a 1-year FD, where we also earn decent interest today. And since this FD is linked to savings account, we can withdraw it whenever we need to or even issue cheques. Thus we get the benefit of both returns and liquidity.

 

Review and replenishment

As time passes, the nature and quantum of our expenses will change. As our child grows, the expenses on his education will increase. But later as he/she starts earning, our expenses will reduce. When we are young, we spend very little on medical needs. But as we grow older this becomes a significant part of our expenses.

 

Therefore, we must review our emergency corpus say every 1-2 years and check whether we are under-protected or over-protected. Accordingly, we need to add money to the fund or take out from it. Also, if ever we have to use these funds for any emergency, we must ensure to replenish it again as soon as we can.    

 

Make sure that you too are ready to face the rainy day with equanimity.

 

The author, Sanjay Matai is an investment advisor. You can reach him at sanjay.matai@moneycontrol.com .