As a thumb rule, it is advised to keep at least three to six months’ worth of basic living (and non-negotiable) expenses as emergency fund.
You are often advised by financial planners to always have an emergency fund in place.
Now, an emergency fund is an amount of money set aside specifically for unplanned, urgent, unexpected and real emergencies that cannot be faced with insurance policies or other means.
A temporary job loss, any uninsured medical emergencies, unexpected travel for tackling family emergencies (and at times helping very close family members in their times of dire need too).
Now let’s come back to the question at hand.
Placing a figure to contingency
As a thumb rule and for starters, it is advised to keep at least three to six months’ worth of basic living (and non-negotiable) expenses as emergency fund. Later on, it can be enhanced to cover six to 12 months’ worth of expenses.
So how do you find out your correct monthly living ( and non-negotiable) expenses?
Here is what you can include:
-Start with critical ones such as rent (and/or home loan EMI), food, non-food consumables, utilities, school fee, transportation (fuel) costs, healthcare expenses, other loan EMIs and salaries for support staff (if any). You may also want to include important yearly expenses such as insurance premiums.
-Other non-critical but regular expenses on entertainment, eating out, vacations, etc. aren’t exactly the categories you spend money on during emergencies. So, those can be left out for starters. The idea is to focus only on basic unavoidable and essential expenses.
By now you would have realized that your living expenses are different from what your colleagues or friends incur. So, just because a friend sets aside Rs 2 lakh for emergencies, it doesn’t mean that the same amount is appropriate for you.
You need to figure out what is best for you.
Apart from what is discussed above, there are few other aspects to consider too:
-Are you are the sole earning member of the family or is your spouse employed too?
-Are you working in a high-risk industry with low job stability?
-How many direct dependents do you have?
-How many occasional dependents do you have in the extended family, who call you for help for their emergencies?
-Do you wish to have added buffer to continue saving for important goals such as retirement and children’s’ education, etc. in times of crisis?
So, thumb rules such as ‘save 6 months’ worth of expenses’ are good to begin with. But, if you really want to secure yourself, you need to take a call on saving more. Sometimes, saving 6 months’ worth expenses may not be enough.
For example - if you are someone who is planned to quit his job and start a new venture, you may want to keep aside enough money for a few years and not just 6 months just to feel safe!
And these days, credit cards can also come in handy in case of emergencies. You can use them to tide over emergencies in the short term. But remember, eventually, you will have to arrange for the funds and pay back. So, a credit card isn’t a substitute for an emergency fund.
Some of you may be worried as to how so much can be saved for emergencies quickly?
Do not worry if you cannot arrange for the funds at once. Very few people can. Do what you can. Build it gradually using your monthly savings. Also, use your bonus to top it up occasionally. If some amounts are stuck in bad products (such as newly purchased traditional insurance policies), exit them and use the proceeds to bolster your emergency fund. Also, if need be, cut down on discretionary spendings for some time.
Where should you keep your Emergency Fund?
-If you are a conservative person, then it is good to stick to fixed deposits. Or, put a small part in the savings account and opt for Flexi-FDs, which have similar liquidity as savings accounts, but deliver better, FD-like returns.
-For others who are less conservative (or wish to park bigger amounts), a combination of fixed deposits and debt funds (liquid funds and/or ultra-short duration debt funds) would work well.
And remember, the size of the emergency fund is dynamic. So, review fund size every year. If you require a larger fund due to change in circumstances (such as the birth of a child, increased expenses, new loan, etc.), make sure you save more.
Also, if you dip into the fund for emergencies, you should replenish it as soon as possible. Do it regularly (via monthly savings) or using your annual bonus partially.(The writer is the founder of StableInvestor.com)